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

Mellon FX Daily 06:30 EDT

Key Points
• USD upside bias remains in place given position liquidation risk and recent data improvements.
• Today’s US employment report will need to be very weak to present an offset.
• This week’s ISMs should also help to bolster next Wednesday’s FOMC statement.
• CAD could be the odd one out against the USD.
• Riksbank leaves rates unchanged but acknowledges need for higher than expected rates in future.

Market Outlook

The USD remains better supported by the US data developments of this week and unless there is a complete disaster in today’s employment report, further USD gains look likely in the short-term as existing short USD positioning is unwound. The 1-mth risk-reversal on EUR-USD (that has been showing a premium of calls over puts) has also fallen back to its lowest level since early March, suggesting fading EUR support from the options market.

Key support in the 1.3460-1.3500 area is likely to be put to the test on EUR-USD during this time (1.3460 being the breakout point for the latest period of strength since early April). Whether this move extends any further will depend upon the nature of next week’s releases, especially the FOMC statement and retail sales. Note that this week’s ISM outcomes are almost doubly important in this regard, as they should ensure that the FOMC will not be downgrading its thoughts about the economy any further for the time being. While there may be some acknowledgement of the more favourable readings on core CPI and core PCE prices over the past month, this is unlikely to translate into an ‘all clear’ on the outlook for price stability. If 1.3460 does break there would be risk down to 1.3340.

If a weak employment report can be avoided today USD advances are likely across the board, with USD-JPY having already eased clear of 120.00 and high-yielders such as the AUD and the NZD also looking vulnerable. The AUD was hurt by a larger than expected trade deficit and the RBA lowering their 2007 CPI forecast to +2.5% from +2.75% previously. However, the RBA also warned that current CPI weakness may not last, stating that “all available data suggest high capacity utilisation, a tight labour market and strong demand growth”. On this basis, the tightening bias remains in place and a further rate hike still looks likely at some point. AUD support is now at 0.8150. 0.8000-50 is major support below this and should hold. NZD has scope to 0.7320 and 0.7260.

A possible exception to generalised USD strength could be USD-CAD, which is the one USD rate that has not been characterised by excessive short USD positioning in recent times. Indeed, the CAD has been strengthening in recent weeks due to the ongoing elimination of prior short CAD positioning. This adjustment is now complete, which removes one negative factor for USD-CAD, but the implications for the CAD of a potentially stronger US economy are not as negative as for other currencies. An improving US economy could actually boost expectations of a BoC rate hike, as the BoC has identified the US as a key downside risk for the Canadian economy. If the USD does recover substantially, a stronger USD-CAD may still be seen, but the CAD is likely to outperform other currencies. 1.1100 and 1.1145 are resistance points on USD-CAD – support is at 1.1025-50.

The Riksbank left rates unchanged this morning, but admitted that rates would need to be raised by more than they initially expected during the rest of this year. The market had been fairly split on the likely outcome of this meeting, but the assurances about future rate hikes have provided some protection for the SEK. The Jun FRA is off 3bps, but the Dec FRA is broadly unchanged on the day. The Riksbank cited stronger than expected developments in the current wage round as the main reason for the upward reassessment, although in light of this and other data developments, the fundamental question is why they failed to raise rates immediately.

The immediate parameters of importance on EUR-SEK are at 9.1770-9.1850 on the topside and 9.12 on the downside, with the ‘big figures’ at 9.10 and 9.20 also carrying some importance. There could be a modest test higher initially following the lack of a rate hike today, but we favour downside overall. The SEK should remain well supported by the solid economic activity backdrop and the fact that the government has now begun its privatisation process (good for foreign inflows).

Day Ahead
US – last month’s employment report was stronger than expected, with non-farm payrolls helped by some upward revisions to February. Weekly hours data was also slightly stronger. The 3-mth moving average of the m/m change in payrolls (+151.7k) remains soft compared to the performance of recent years, but it is still above the 10-yr average of +131k and is not currently weak enough to be a serious threat to consumer spending. As long as such weakness can be avoided (key today), any broader pick-up in economic activity, such as that tentatively signalled by this week’s ISM surveys, should help to nurture the idea that the labour market (a lagging indicator of output) will ultimately remain well supported.

Data/event EDT Consensus*

US Non-farm payrolls (Apr) 08.30 +100k
US Unemployment rate (Apr) 08.30 4.5%
US Average workweek (Apr) 08.30 33.8
US Hourly earnings (Apr) m/m 08.30 +0.3%
US Fed’s Geithner on global economy 09.45
CA PMI (Apr, nsa) 10.00 57.3
US Fed’s Hoenig speaks 11.20

Latest data Actual Consensus*
AU Trade balance (Mar) -A$1.6bn -A$1.1bn
SE Riksbank repo announcement unch unch/+25bp
ES PMI services (Apr) 54.2 56.7 last
IT PMI services (Apr) 53.9 54.3
FR PMI services (Apr) 58.7 59.4
DE PMI services (Apr) 57.8 57.9
EU PMI services (Apr) 57.0 57.6
NO Unemployment rate (Feb, sa) 2.7% 2.6%
EU Retail sales (Mar) m/m +0.5% +0.5%
* 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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