Market Matters Foreign Exchange Market Report FX Snapshot 24 May 2005   USD Is the bond market or the Fed right? The disconnect between what the Fed thinks is happening in the US economy and what the bond market thinks is growing. The yield curve is now at its flattest since the aggressive rate cutting cycle of 2001. The difference between the 10yr Treasury note and the 3-month interest rate is now less than 100bps versus over 300bps in mid ’04. How this plays out is crucial to the US dollar’s outlook. Any difference in opinion between the Fed and the bond market is likely to be transitory. Rising interest rates have been a supportive factor for the USD. However, the key is the willingness of foreign investors to fund the US current account deficit, which apparently weakened in March. Any shock to the markets could severely damage this willingness. A key near-term concern is the record speculative long USD positions, which could lead to a significant sell-off once sentiment shifts. Remember, the adjustment of large speculative short positions was how the current USD rally started in late December. EUR Data, data everywhere, but don’t forget politics This week sees a raft of data, which is likely to tell a depressingly familiar story – the European economy remains sluggish. However, this may prove unimportant as we head towards next week’s vote on a revised EU constitution in France on May 29. The risk of rejection is high. Meanwhile, it still has to be passed elsewhere with the Netherlands also holding a similar vote on June 1. Any no vote is sufficient to derail the new constitution. The EU budget is also up for debate and we can expect fireworks here. The UK has indicated it expects its rebate to remain in force. But the process is likely to be slowed by German Chancellor Schroeder’s decision to hold early domestic elections. With neither economics nor politics in support of the EUR for now, we expect it to lose further ground in the near-term. JPY BOJ manages policy shift well The Bank of Japan’s decision to allow the amount of reserves available to lenders to fall temporarily below JPY 30 trillion passed with barely an acknowledgement by the market. The fear had been that by being viewed as a tightening of monetary policy, it could push bondyields higher and the JPY firmer. With this behind us, the JPY should remain on the defensive near-term, although signs of an economic rebound should ultimately push USD/JPY lower. GBP Next move is likely to be a cut The Bank of England’s Inflation Report focused on the risks to growth, signalling it has come around to our view that another rate hike was unnecessary. Of course, within the BOE’s Monetary Policy Committee this is not a unanimous opinion with one member still arguing the case for an immediate 25bps hike. However, this apparent shift in focus, together with particularly weak data of late, last week’s retail sales notwithstanding, has led us to conclude that the next interest rate moves will be a cut, albeit not until 2006. Narrowing interest rate differentials with the US are likely to keep GBP/USD under pressure in the near-term. AUD Strong data fail to fuel AUD rebound A wave of stronger than expected data failed to fuel a significant AUD rebound as this was seen as consistent with the economic cycle peaking. Clearly, the RBA remains concerned about potential inflationary pressures re-emerging and wage data will have reaffirmed this concern. However, even if the RBA were to hike interest rate, it looks unlikely that this would be sufficient to halt the AUD’s decline, especially if commodity prices remain weak. CAD Relief rally on politics The CAD benefited from the approval of the budget, albeit by a single vote, allowing thegovernment to hang onto power for now. However, the trend for CAD weakness remains with commodity prices still very weak amidst a broad-based rise in the USD. The main thing towatch out for, aside from the Bank of Canada’s interest rate announcement on Wednesday, isthe increasing risk of a USD correction following the largest level of speculative long positionsagainst other major currencies, since the start of the EUR, being recorded. SGD Data far from impressive Economic data remains generally weak, the bounce in retail sales notwithstanding. Tuesday sees the release of inflation data, which we expect to remain particularly benign. AUD/SGD remains vulnerable looking forward. However, interestingly, GBP/SGD is approaching key psychological and technical support around 3.00. This was the high during the Asian crisis and has acted as very good support since breaking higher in late 2003. We expect this level to hold near-term, but ultimately a plummeting GBP could bring GBP/SGD dramatically lower. IDR Forming a short-term base The recent inflow of funds relating to Philip Morris purchase of the country’s third-largest cigarette maker for USD 5bn has helped temporarily solve the USD demand-supply imbalance, which led to rupiah weakness earlier in the year. Bank Indonesia responded by slowing dramatically the pace of interest rate hikes at its weekly auctions. However, FDI inflows should dry up this week and we expect the rupiah to start losing some of its shine going forward. How the central bank responds will be crucial to determining its credibility. With the Indonesian President travelling to the US, one would expect a more aggressive stance if the rupiah starts looking really shaky. INR Deteriorating trade balance has limited impact Evidence of strong import demand, and a corresponding deterioration in the trade balance, has not undermined support for the rupee. The question is will it? We continue to look for the current account surplus to deteriorate going forward. However, we also expect foreign investment, particularly FDI, to accelerate and offset any deterioration. Therefore, any rupee weakness is expected to be limited. ZAR ZAR continues its slide The South African Reserve Bank continues to get its desire for a weaker currency with the rand falling sharply once again last week. The difficult situation in Zimbabwe, evidenced by a pseudo-devaluation last week, hardly helped sentiment in currency markets, although interestingly the stock market has had a good run since the end of April. Still, it is clear that the rand is overvalued and while a correction is entirely natural from such an over-extended position, the trend for USD/ZAR appears to be in a northerly direction. This has implications for inflation later in the year, which is expected to accelerate in data to be released this week. Key Levels Currency Support Resistance EUR/USD 1.2450 **** 1.2200 *** 1.2785 **** 1.3000 ** USD/JPY 106.20 ** 104.20 **** 108.90 **** 109.90 *** GBP/USD 1.8145 **** 1.8000 ** 1.8595 ** 1.8800 *** AUD/USD 0.7440 **** 0.7380 *** 0.7680 ** 0.7800 **** USD/CAD 1.2475 ** 1.2300 *** 1.2675 *** 1.2850 *** USD/SGD 1.6425 **** 1.6250 *** 1.6685 *** 1.6830 **** USD/IDR 9400 **** 9335 **** 9530 ** 9620 *** USD/INR 43.10 **** 42.75 ** 43.85 **** 44.10 ** USD/ZAR 6.4200 ** 6.2500 ** 6.8350 **** 7.0650 *** Key: (*)-Minor; (*****)-Major Key Events Event Day Implication Singapore CPI Tuesday Expected to remain benign German Q1 GDP, revised Tuesday No revision to initial estimate expected, growth largely export-led with domestic demand weak UK Q1 business investment Tuesday Y/y rate expected to slow German ZEW investor survey Tuesday Worries over economy and EU constitution vote to keep sentiment weak Eurozone industrial new orders Tuesday   German CPI Tuesday Y/y rate expected to remain steady at 1.6% US May 3 FOMC minutes Tuesday Interesting to see how confident of the recovery they were before the strong employment was released Japan merchandise trade balance Wednesday   South Africa CPI Wednesday Fuel price increase suggests inflation is likely to rise Japan BOJ policy meeting minutes Wednesday Debate surrounding current account targets the focus German IFO business confidence Wednesday Expected broadly flat m/m UK Q1 GDP, revised Wednesday Soft manufacturing points to slight downward revision UK CBI Industrial trends survey Wednesday   US durable goods orders Wednesday   Canada BOC interest rate announcement Wednesday No rate move expected ECB’s Trichet speaks Wednesday Expected to hold firm on no rate cut stance for now Singapore industrial production Thursday Expected to weaken sharply y/y South Africa PPI Thursday Softening seen y/y US Q1 GDP Thursday Better trade and retail sales point to significant upward revision Japan CPI/retail trade Friday Deflation continues while rebound in consumer sentiment point to rebound from soft April figures UK lending data Friday   US personal income/spending Friday Focus will be on the core PCE deflator which we expect to remain stable at 1.7% y/y Recent FX Performance (%, +ve = USD decline) Currency Past 1 Week 1 Month 3 Months 1 Year EUR/USD -0.59 -3.87 -3.92 2.76 USD/JPY -0.78 -2.00 -2.32 1.90 GBP/USD -1.27 -4.56 -3.55 -0.32 AUD/USD -0.71 -3.24 -4.10 5.81 USD/CAD -0.06 -2.46 -2.74 7.61 USD/SGD -0.05 -0.69 -1.19 2.44 USD/IDR 0.26 2.43 -2.12 -1.96 USD/INR -0.06 0.64 0.90 4.65 USD/ZAR -3.06 -7.39 -9.25 -0.34 This document has been prepared by Standard Chartered Bank ("SCB") Global Research for information purposes only. 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