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Friday July 13, 2007 - 10:35:18 GMT
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Forex Research - Mellon FX Daily – U.S. Edition

Mellon FX Daily – U.S. Edition 5:50 EDT

Key Points
• Global markets shrug off concerns about risk aversion.
• Weak USD theme will face another test today from US data.
• JPY outlook remains poor – AUD and NZD looking good.
• US retail sales, Michigan sentiment and business sales inventories feature today.

Market Outlook

So much forrisk aversion. Some key US equity indices closed at record highs yesterday, the JPY weakened afresh against most currencies and high-yielders such as the NZD and AUD are also looking good. The USD remains weak and as noted yesterday, as long as global markets remain buoyant this will snuff out a potential positive for the USD i.e. possible repatriation of funds back into the USD investor base.

While there has been much focus on the sub-prime issue as being the cause of the USD’s latest problems, the damage was done a couple of weeks back when EUR-USD broke above 1.3485, thereby ending the consolidation pattern that had been in place since the end of April. The S&P sub-prime announcement on Tuesday was merely the catalyst for EURUSD to take out the April high of 1.3683. Also note that this latest period of USD weakness has developed in an environment where the US economic data has been strengthening, so claims about economic risk do not exactly ring true. There is clearly some uncertainty about the possible broader impact of the sub-prime issue, but the fallout for the rest of the economy should be fairly limited. Essentially the EUR-USD move is all about momentum and for the time being this remains positive.

This apparent detachment of the USD from the underlying economic data will again be put to the test today, with retail sales, Michigan sentiment and business sales/inventories all due. It will be interesting to see whether EUR-USD is able to advance in the face of any data strength, as it did last Friday after the employment report. Whether it can do so will be a good test of how durable current momentum is. 1.3800 is the level that needs to break to keep upside alive for today, while important levels on the downside come in at 1.3735-40 ahead of 1.3680-1.3700.

The JPY has remained weak and the outlook is grim with global markets stabilising and no sign at all of any turnaround in BoJ rate expectations. Further weakness looks likely in the short-term.

The AUD has advanced well in this environment and with it trading at 18-year highs there are few obvious technical targets at the current time. 0.8950 is the high from 1989.

NZ retail sales data was stronger than expected last night and this is a significant development for the NZD as such data had the capacity to undermine current yield arguments. The avoidance of weak data should mean the NZD is able to advance further in the short-term and the recent high around 0.7880 (already retested overnight) is likely to be taken out over the coming week.

Complicating things earlier today was an announcement by the RBNZ, suggesting that they will move away from their current unusual position of having all of their FX reserves matched by foreign liabilities. From now on they will allow a so-called ‘unhedged’ FX position to develop. The move is largely technical and has arisen as an issue because the recent intervention was the first to be ever carried out by the RBNZ. It will have no real implications for the current intervention campaign. However, the market may be slightly concerned/bemused that currently the RBNZ has no net FX reserves!

Day Ahead
US – retail sales, Michigan sentiment and the business sales/inventories report are today’s main data features. Retail sales will be the major focal point after the June slippage in a number of consumer confidence measures. Sales have been proceeding at a solid pace during 2007 and with fuel prices again a factor, one should perhaps look at sales excluding autos and gas stations for a better indication of the underlying trend. Sales ex-autos and gas were weak in Apr (-0.2%), but bounced back well in May (+1.0%). This may just be a sign of short-term volatility, in which case a weak number could yet follow for June. However, as it currently stands, the 3-mth moving average for the m/m rise in this series stands at a relatively high +0.5% - the joint highest (with Feb) since Mar last year. The 3-mth annualised rate has also been improving from the depths of last year (see chart). After the strength seen in all of the main headline numbers last time, there is a clear ‘statistical’ risk of a weaker number on this occasion. However, it will need to be fairly weak and/or accompanied by downward back revisions to cause any major disappointment.

The latest Michigan sentiment number will be monitored to see whether there has been any rebound from the weakness recorded in June. The last couple of weekly ABC consumer comfort measures have been well off the lows seen throughout June, so there is some room for cautious optimism.

Business sales should maintain the strength of recent months, consistent with the improvements seen in other measures of business activity. Optimism would be further enhanced if stronger sales are accompanied by any strength in inventories, as such a combination would suggest that ‘voluntary’ inventory rebuilding is taking place (a big plus for output growth). This would add weight to the growing market belief that the inventory cycle bottomed in Q1. Sales have been outstripping inventory growth in the past two months, as shown in the lower inventory sales ratio (see chart).

Data/event EDT Consensus*
US Retail sales (Jun) m/m 08.30 -0.1%
US Retail sales ex-autos (Jun) m/m 08.30 +0.2%
US Retail sales x-autos/gas (Jun) m/m 08.30 +1.0% last
US Import prices (Jun, nsa) y/y 08.30 +1.1% last
US Imp prices ex-petrol (Jun, nsa) y/y 08.30 +2.8% last
US Michigan sentiment (Jul, prel) 10.00 86.0
US Business inventories (May) m/m 10.00 +0.3%
US Business sales (May) m/m 10.00 +0.7% last

Latest data Actual Consensus*
NZ Retail sales (May) m/m +1.2% +0.5%
FR CPI (Jun) y/y +1.3% +1.3%

* Consensus unless stated

©2007, 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.


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