By Mike Jones

NZD

Investor risk appetite and the EUR/USD were crunched overnight by the news the Italian election has failed to deliver a clear result.

But the NZD has been relatively resilient to all this, in part thanks to solid NZD/AUD buying.

The NZD/USD opens this morning around 0.8385, a smidge above where it started the week.

Yesterday’s HSBC Flash PMI suggested the expansion in Chinese manufacturing throttled back a gear in February.

The headline index slipped from 52.2 to 50.4 – still consistent with expansion, but without much room for error. Investors expressed their disappointment via a lower AUD/USD.

Speculative and leveraged players were also quick to re-establish NZD/AUD longs in the wake of the figures, lifting the cross from 0.8110 to 0.8150.

We suspect the NZD/AUD will struggle to gain a foothold above 0.8200 in the short term.

Not only are expectations of RBA easing receding (watch AU capex numbers on Thursday), but our short-term valuation model suggests the cross starts to look 'expensive' above 0.8230.

We nonetheless retain our constructive medium term view. We forecast NZD/AUD at 0.8500 by mid-year.

Overnight, currencies were pushed and pulled all over the place as investors reacted to exit polls from the Italian elections (see Majors).

In the end, the grim reality of a hung parliament has seen the EUR and risk sentiment finish the night in bad shape. As a result, the NZD/USD opens this morning a good ½ cent below its overnight highs around 0.8420.

Today’s RBNZ Survey of Expectations will likely register restrained 1-to-2-year-ahead CPI inflation expectations, with more interest on pollsters’ thoughts on GDP and CPI.

In Australia, the RBA’s Debelle is speaking in Adelaide. Tonight, all eyes will be on Fed Chairman Bernanke’s latest testimony before the Senate.

Key for the NZD/USD is whether Bernanke reconfirms the Fed’s easing bias and hence undermines the USD.

We continue to hold a downside bias for the NZD/USD this week, albeit with dips expected to be shallow and short-lived.

Support at 0.8280 should hold. Initial resistance will be encountered on bounces towards 0.8425.

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Majors

It was a wild ride in currency markets overnight. The EUR/USD flew around in a wide range as investor sentiment was whipped around by Italian election uncertainty.

The USD has finished the night a little stronger relative to most of the majors.

Early exit polls pointing to a victory for the centre-left Bersani saw good cheer spread far and wide.

European equity markets notched up gains of 0.3-1.5%, 10-year Italian government bond yields slid to around 4.2%, and the EUR/USD climbed over a cent to above 1.3300.

However, the initial euphoria later dissolved as the polls began to suggest a Berlusconi-led centre-right (anti austerity, anti EUR) coalition might have the numbers to lead the Italian senate.

Italian bond yields soared, US stocks erased their early gains (the S&P 500 is currently down 0.4%), and the EUR/USD tumbled from 1.3300 to almost 1.3100.

Official results are due to be released sometime later this afternoon or evening. But, with the left lacking the votes to lead and the right seemingly unable to form a workable coalition, it looks like Italy may soon be heading back to the polls.

This political uncertainty will likely keep the EUR under pressure in the short-term. We suspect the EUR/USD will find it tough going towards 1.3200.

Aside from Italy, currency markets will also be taking direction from tonight’s Testimony from Fed Chairman Bernanke.

Investors are hoping Bernanke pushes back against speculation the Fed could begin to tone down its QE policies from later this year.

A failure by Bernanke to recommit to QE will fan the flames of risk aversion ignited by Italy’s political woes, further bolstering sentiment towards the USD.

Other News:

*Chicago and Dallas Fed manufacturing indices come in a touch softer. Chicago index prints at -0.32 from 0.02 in December, Dallas index falls to 2.2 in February (5.5 in January, 3.5 expected).

* German IFO 107.4 in February (104.9 expected).

Event Calendar:

26 February: AU RBA’s Debelle speaks; US Fed’s Lockhart speaks; NZ RBNZ 2-year inflation expectations; US house prices, consumer confidence, and home sales; US Fed’s Bernanke testifies;

27 February: NZ net migration; NZ trade balance; NZ FM English speaks; UK GDP; US durable goods orders; US pending home sales; EU ECB’s Draghi speaks;

28 February: NZ building permits; AU new home sales; NZ ANZ business confidence; AU Capex; EU German unemployment; US jobless claims;

1 March: NZ terms of trade; CH PMI; EU PMIs; UK PMI; US ISM manufacturing.

All its research is available here.