NEWS / Fiscal Policy, Budget

Forex - Mellon FX Daily - U.S. Edition

Key Points
??? Global market sentiment improves ??“ supporting emerging currencies.
??? USD weaker on Chinese diversification story, although there is nothing new in this.
??? FX majors continue to look fairly range-bound.
??? AUD remains favoured over the increasingly vulnerable CAD.
??? US consumer confidence and existing home sales feature today ??“ Australian CPI tonight.

Market Outlook
The solid (US-led) recovery in global equity markets has offered support for emerging markets with Middle East uncertainties stabilising a little and the market still inclined to take a more positive view of the US backdrop after Bernanke??™s testimony of last week. However, this is unlikely to automatically proceed to a straight-line recovery. There is potential for a resurfacing of such uncertainties at some point over the coming week, depending upon developments in the oil price as well as the US data. Sentiment remains delicately balanced in this regard.

For now it looks like being another day of gains for emerging currencies and this should also translate into a weaker USD on the majors, but sizeable movements are unlikely. EUR-USD needs to get above 1.2725 to trigger some interest ??“ support remains at 1.2590-1.2605. Indeed, against the majors the USD was still looking fairly solid until some comments from China (04.00 GMT) about the need for a speedier diversification in its FX reserves. However, these comments came from the National Bureau of Statistics, which has no responsibility for reserve management. If this was the only reason for the EUR-USD advance (which earlier in Asia was at 1.2605) then one has to be a little sceptical about it, although other developments in relation to risk appetite should be mildly negative for the USD. Overall, the majors do not look exciting at the present time.

More weak data out of Canada yesterday left the CAD looking vulnerable, but the bout of USD weakness late Asia sent USDCAD back below 1.1400. However, a higher USD-CAD still looks the most likely outcome in the short-term, with risk up to 1.1525-50. Note also that other crosses are starting to develop against the CAD, especially AUD-CAD, which yesterday traded well above the May high at 0.8610. It has since pulled back a little but remains around 0.8600 and there is a fair chance of a move up to 0.8740-0.8825 in the short-term. EUR-CAD needs to get through 1.4475 (tested yesterday) to introduce some CAD negativity from that angle.

The AUD remains favoured in general ahead of next week??™s likely RBA rate hike and Australian CPI is out tonight (see below for preview). A break above 0.7570 remains favoured on the AUD, which would leave risk up to 0.7650.

The Eurozone current account deficit widened further in May to an adjusted ?‚¬8.2bn, leaving the 12-mth cumulative balance in a deficit of ?‚¬47.6bn compared to a ?‚¬28.8bn surplus at the same time last year. While all of this deficit is accounted for by income and transfers, the vast bulk of the deterioration was a ?‚¬54bn fall in the goods surplus (related to higher energy and material prices). There was a net inflow of ?‚¬49bn on portfolio account - ?‚¬44bn in debt instruments, ?‚¬5bn in equities. The net inflows in equity were accounted for by net sales of foreign securities by euro area residents (?‚¬13bn) that were only partly offset by net sales of euro area equity by non-residents (?‚¬8bn) ??“ overall evidence of repatriation and liquidation on both sides. The net inflows in debt instruments were mostly due to net purchases of euro area bonds and notes, as net purchases of euro area securities by non-residents (an unsually large ?‚¬69bn) by far exceeded net purchases of foreign securities by euro area residents (?‚¬25bn).

Day Ahead
US ??“ consumer confidence and existing home sales are the data features. Consumer confidence could slip a little if the recent Michigan estimate is any guide, while the weekly ABC numbers have actually been recovering a little. Existing home sales have been fairly volatile in recent months, although looking at the more stable pending home sales number it seems clear that the overall trend is down. To this extent there is a risk of a weaker number today.

Australia ??“ Q2 CPI is due this evening and it will take a very weak number to offset current arguments in favour of an August 2 RBA rate hike, such is the strength in other data (e.g. labour market and private sector credit). The last set of CPI numbers was a mixed bag. In Q1, headline CPI moved up to +3.0% y/y, while the RBA??™s measure of core inflation also edged up to +2.6% from +2.3% in Q4. However, total CPI excluding volatile items was only +2.2%, down from +2.3%, while market (private sector) prices ex-volatile items also fell back to +1.7% from +1.8%.

Diary
Data/event EDT Consensus*
US Chain store sls (w/e Jul 22) w/w 07.45 -0.6% last
US Redbook sls (w/e Jul 22) m/m 08.55 -2.2% last
NZ Business confidence (Jul) 09.00 -32.2 last
US Consumer confidence (Jul) 10.00 104.1
US Existing home sales (Jun) 10.00 6.60m
US ABC consumer conf (w/e Jul 23) 17.00 -9 last
NZ Trade balance (Jun) 18.45 -NZ$385m
JP Trade balance (Jun, sa) 19.50 ??627bn
JP CSPI (Jun) y/y 19.50 -0.1%
AU CPI (Q2) q/q 21.30 +1.0%
AU CPI (Q2) y/y 21.30 +3.4%
AU CPI mkt prices ex-volatile (Q2) y/y 21.30 +2.0%
AU CPI-RBA trimmed-mean (Q2) y/y 21.30 +2.6% last

Latest data Actual Consensus*
DE Import prices (Jun) y/y +5.6% +5.9%
FR Own company ind outlook (Jul) 13 12
FR Business climate indicator (Jul) 109.0 108.0
IT Business confidence (Jul) 96.7 98.8
EU Current account (May) -?‚¬8.2bn -?‚¬1.3bn
* 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