Forex Update - USD

The US dollar has started the week staying firm against the majors, trading in a 1.2490-1.2510 range against the EUR and a 119.65-119.80 range against the JPY this morning in Asia. Low risk aversion and receding expectations that the Fed will cut rates in the near term continue to help the dollar.

On Friday retail sales excluding gasoline and autos supported the USD and University of Michigan consumer sentiment index jumped to 92.3 in early October - the highest level in two years - from 85.4 in September.

According to Fed Funds futures, the market is currently only pricing in a 25bps rate cut in 2007, reducing rate cut expectations significantly from a fortnight ago. Medium terms risks are still for the USD to decline as we expect the slowing housing market will cause the Fed to cut interest rates by 100bps next year, while appetite for carry trades is unlikely to be sustained at current strong levels.

But in the near term we recognise that short USD position capitulation, a resolute Fed, stronger equity markets and continuing capital inflows into the US as given by both our Equities for FX and FX Flow Monitor all suggest the USD will be stronger in the short term for longer.

This week, US PPI (Tuesday) and CPI (Wednesday) data for September are due, along with the October Housing Market Index (Tuesday) and September housing starts (Wednesday) and the TIC data on Tuesday. We expect these data to show a weakening housing market, a gradual slowing in broader activities and moderate price pressures, while capital flows are likely to remain USD supportive.

Ahead today, Fed chairman Bernanke (1730GMT), Fed's Poole (1730GMT) and Yellen (1940GMT) are all due to speak, while the Empire State index for October is the only data due today.