Key Points
EUR-USD bias still upward as it stays above last week's breakout point.
However, IMM data suggests high long EUR positioning.
USD-JPY bounces back after initial Asian weakness.
US housing data and FOMC statement in focus this week.
Media awash with rumours about UK Budget.

Market Outlook
EUR-USD has pulled back a little overnight, but remains above last week's breakout point around 1.3250-60 and as long as this remains the case there will be some upside risk. However, unless 1.35 breaks we would not see a major move in EURUSD at the present time. The Dec 4 high at 1.3367 is the immediate level of interest on the upside. The latest IMM positioning data also suggests that the market is already long of EUR-USD, so positional issues could also constrain upside progress. As of last Tuesday, IMM data showed that spec net longs on EUR-USD rose to 96,155k contracts from 88,679 the previous week and only just below the record high of 102,598 contracts seen a couple of weeks back. With EUR-USD having advanced further since Tuesday, positioning is also probably even higher by now.

USD-JPY weakened early in Asia on news that China had hiked key interest rates by 0.27%, although this was short-lived, with the JPY weakening quite sharply as the rally in the Nikkei eased fears about liquidation of short JPY positioning. USD-JPY strength continued in Europe, with European equity indices also higher. Latest IMM positioning showed net long USD-JPY positions at 52,853 contracts, down from 62,886 contracts previously and well below the record highs seen a few weeks back. Net positioning is still fairly high but the ongoing normalisation in this situation will enhance confidence that the current corrective phase could be limited to 114.50-115.00. Choppiness between 114.50 and 120 still seems the most likely scenario in the short-term.

The key events for FX market sentiment this week will be the FOMC statement and status of the US housing data. The NAHB housing index is due today (see below for preview), while housing starts, building permits and existing home sales also feature this week. The FOMC statement will be watched to see how much they acknowledge the recent weakening in some of the economic data.

The worst-case scenario for USD-JPY would be very weak US housing data, not only via the interest rate implications, but also due to the fact that such a development would aggravate concerns about sub-prime mortgages and hurt high risk assets in general (supporting the JPY). The FOMC statement is more of a double-edged sword. A dovish statement would be USD negative on the face of it, but more so against the EUR than the JPY. Such Fed dovishness would be comforting for equities and emerging markets and could offer some support for the weak JPY argument.

Reports in the weekend press suggest that Wednesday's UK Budget may be more dramatic than first thought. There is growing speculation about the likelihood of a cut in corporate taxation and there are also rumours about a more widespread simplification of business and personal tax system. This would be a dramatic final act by Brown as Chancellor and would help to nullify much of the political opposition's arguments against the nature of UK fiscal policy. In this regard, it would be a useful platform for Brown to take over as PM. Such a Budget would also offer some support for GBP and this could explain some of the GBP outperformance seen this morning. Below 0.6820 is needed on EUR-GBP to add credence to the view that a shortterm top has been established at 0.6860-70.

Day Ahead
US - today sees the first in a number of releases scheduled for this week about the US housing market, which has become an increasingly sensitive issue in view of the concerns about the sub-prime mortgage market. The NAHB housing index is the product of a survey of builders, combining measures relating to current and expected sales and the number of prospective buyer inquiries. This jumped to 40 in February (the highest since June) and fairly clear of the 30 low seen in September. However, it remains well below the 65-70 area occupied for much of 2005.

Japan - after last month's rate rise, Tuesday's BoJ policy meeting outcome should be a non-event, although the market will be keen to see Fukui's take on recent data releases, which CPI apart, have been more favourable.

Diary
Data/event BST Consensus*
 
CA Net portfolio balance (Jan) 08.30 -C$8.9bn last
CA Wholesale sales (Jan) m/m 08.30 -0.7%
US NAHB housing index (Mar) 13.00 38
JP BoJ rate announcement unch
JP BoJ monthly report 02.00
Latest data Actual Consensus*
GB Rightmove house prices (Mar) y/y 12.2% 11.5% last