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Forex Research - Mellon FX Daily - U.S. Edition

Mellon FX Daily 06:05 EST

Key Points
• Much damage done by yesterday’s price action, suggesting more global market weakness over the coming week.
• Both JPY and CHF are likely to gain further in the short-term.
• EUR-USD also at risk if general market positioning is cut back and real money flows back into the USD.
• US GDP, Chicago PMI, new home sales feature today.

Market Outlook

A rollercoaster session for equities yesterday, with the reining back of risk appetites also meaning that JPY shorts were progressively squeezed. The inevitable question is how long any adjustment in market positioning lasts and whether the development is a short-term phenomenon or the beginning of something more prolonged.

For equities and other high risk markets, basic economic fundamentals are pretty much the same as they were last week, when many indices were making fresh highs, so what’s changed? It is basically a case of Dr Jekyll and Mr Hyde. Dr Jekyll exists via the fact that in most cases the consensus expectation is for solid non-inflationary growth. Indeed, if there is any slippage in this backdrop, especially in the US, the FOMC will be on hand to cut rates if things start getting ugly. Dr Jekyll has clearly been taking centre stage for most of the past six months.

However, Mr Hyde has always been lurking in the background, representing the fear that too much liquidity has been put on the table, a fair amount of it leveraged, and that at some stage the liquidity machine will come to a grinding halt. The big fear here is that the correction is substantial and will itself start to feed fears about financial dislocation, with negative consequences for the basic fundamental story. Mr Hyde duly appeared yesterday.

After the severity of the movements seen yesterday, it would be a remarkable feat if the market is able to dust itself down and to recover promptly. First of all, many will have been previously taking the view that is was possibly time to take some money off the table, but why bother when markets keep going up? That mentality has been dealt a severe blow by what happened yesterday and is likely to mean selling on rallies. Second, is the issue of price durability. With such hefty price falls fresh in the memory, those setting prices are likely to respond more quickly if any selling pressure emerges. On balance, we do not subscribe to the doomsday scenario and believe that markets will eventually recover their poise, but this could take some time and there is probably worse to come in the short-term.

On this basis, both the JPY and the CHF will remain the favoured currencies for now, even though a return to weakness is likely at some point. From a broader perspective, any currency having previously enjoyed excess positioning will be at risk and EUR-USD should be included under this heading, despite the fact that for much of yesterday it was pushing higher. Net long EUR-USD positioning reached a record high on the IMM as of last Tuesday and if there is a big flow out of emerging markets, this tends to offer support for the USD via flows back into the USD investor base. Yes, the USD could have some ‘flight-to-quality’ element to it in this regard! Some weak US data will be needed to prevent EUR-USD downside (the latter still being favoured).

While yesterday’s durable orders numbers were disappointing, there were some offsetting bright spots – consumer confidence and home sales. More data is due today, with Chicago PMI perhaps the highlight ahead of tomorrow’s ISM report. In terms of levels, 117.50-118.00 is immediate support on USD-JPY, although 115.00-50 is feasible this week. On EUR-USD, 1.3250-60 is resistance but downside is favoured, with support at 1.3140-50 ahead of 1.3060. EUR-JPY risk down to 154.50- 155.00, but above 157.00 would offer relief.

Day Ahead
US – the 2nd estimate of Q4 GDP, new home sales and Chicago PMI feature today. The market is expecting a sharp downward revision to the Q4 GDP number due to lower contributions from inventories and net exports. New home sales bounced back further in December from the very low levels seen in October, although uncertainty about what is happening in the housing market is unlikely to be resolved by today’s report. The data is volatile at the best of times and there is the added uncertainty regarding the possible effect of a mild winter. Chicago PMI will be watched more closely than usual after it seemingly preempted last month’s ISM weakness. Chicago PMI fell to 48.8 last month. After the weakness seen in yesterday’s durable orders report there is an extra onus on the ISM to bounce back above 50.

Data/event EDT Consensus*

US Mortgage apps – purchases w/w 07.00 -4.8% last
ZA Trade balance (Jan) 07.00 -R4.0bn
US GDP (Q4, 2nd est) saar 08.30 +2.3%
US Core PCE prices (Q4, 2nd est) saar 08.30 +2.1%
US Fed’s Geithner on liquidity and financial markets 08.50
US Chicago PMI (Feb) 09.45 50.0
US New home sales (Jan) 10.00 1080k
AU Private new capex (Q4) q/q 19.30 +3.5%

Latest data Actual Consensus*
FR Unemployment rate (Jan) 8.6% 8.6%
FR ILO job seekers (Jan) m/m +1k -20k
US ABC consumer conf (w/e Feb 25) -1 +1 last
JP PMI manu (Feb) 53.0 53.4 last
JP Retail sales (Jan) y/y -0.8% +0.1%
JP Ind prod (Jan, prel) m/m -1.5% -1.8%
AU Private sector credit (Jan) m/m +1.3% +1.0%
JP Housing starts (Jan) y/y -0.7% +4.0%
GB N’wide house prices (Feb) m/m +0.7% +0.5%
FR Consumer confidence (Feb) -23 -23
SE Retail sales (Jan) m/m -0.6% +0.2%
DE Unemployment (Feb) -79k -40k
DE Employment (Jan) +43k +46k last
EU CPI (Jan) y/y +1.8% +1.9%
EU CPI ex-energy/fresh food (Jan) y/y +1.8% +1.8%
EU Unemployment rate (Jan) 7.4% 7.4%
EU Econ sentiment (Feb) 109.7 109.1
EU Business climate index (Feb) 1.56 1.41
GB Consumer confidence (Feb) -8 -8
CH KOF indicator (Feb) 1.79 1.68
* Consensus unless stated

2005, Mellon Financial Corporation Note: Although obtained from sources believed by us to be reliable, Mellon Financial Corporation and its affiliates cannot guarantee the accuracy or completeness of the information upon which this report is based. This report does not purport to disclose the risks or benefits of entering into particular transactions and should not be construed as advice in any specific instance. The views in this report constitute our judgement as of this date and are subject to change without notice.
Ian Gunner 44 20 7163 5996 06.40 EDT Monday May 31 2005


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