Opinion: NZ$ breaks above 69 USc ahead of RBNZ rates decision

By Danica Hampton The NZD has been one of the strongest performing currencies over the past 24 hours. Short-term speculative players took advantage of the holiday thinned session (US markets were closed for Labour Day) to gun for the reported option barrier at 0.6900. The break above 0.6900 triggered a rush of stop-loss buying and the NZD/USD surged to fresh year-to-date high just over 0.6930. Aside from the action in NZD, there wasn't a lot going on in currency markets. Upbeat German factory orders helped EUR/USD nudge up from around 1.4310 to above 1.4360. Meantime, GBP/USD slumped from above 1.6440 to below 1.6340 following news that Cadbury had rejected Kraft's proposal to combine the new companies. On balance, the USD drifted lower "“ helped along by modest gains in European equities and solid risk appetite. It's worth noting, the recent NZD strength has been accompanied by growing conviction the NZ economy will emerge from recession later this year. The improving fundamental backdrop has seen the "˜fair value' range for NZD/USD (according to our short-term valuation model) edge higher over the past fortnight, to around 0.6800-0.7000. However, we'd caution that this range is susceptible to a correction in NZ interest rates. Should NZ-US 3-year swap spreads contract 20-30 bps from the current 2.80% (possible if this week's RBNZ statement convinces markets that rate hikes are unlikely until mid next year), this would lower our "˜fair value' estimate to around 0.6600-0.6800. The NZD/USD will continue to take its cues from global equities and risk appetite, but local events are expected to play a larger role this week. While the break above 0.6900 saw NZD/USD spurt higher, ahead of the RBNZ decision on Thursday we suspect NZD/USD will struggle to break through the technical resistance layered in the 0.6945-0.6965 region. On the downside, initial support is eyed ahead of 0.6910. We'll need to see a daily close below 0.6900 to confirm the uptrend has stalled and suggest a deeper correction is on the cards. The USD dribbled lower against most major currencies last night in a holiday thinned session. US markets were closed for Labour Day. Solid gains across Asian and European equities kept risk appetite buoyant, which provided some support for currencies like AUD, NZD and EUR early in the offshore session. The Nikkei rose 1.3%, the DAX rose 1.5% and the FTSE closed up 1.7%. EUR sentiment was also helped by upbeat German Factory Orders (which rose 3.5% in June, well above forecasts of 2.0%). Steady demand for EUR/USD and EUR/JPY from model-driven accounts helped EUR/USD climb from around 1.4310 to above 1.4360. Despite the generally weaker USD, GBP/USD plunged from above 1.6440 to below 1.6340. British company Cadbury rejected US company Kraft's proposal to merge the two companies. Media attention focusing on the Chamber of Commerce's call for the Bank of England (BoE) to cut rates to zero to ensure the recovery does not falter did little to help GBP sentiment. The BoE meet this week, but both the policy rate and its quantitative easing program are expected to be left unchanged. The appetite for risk and the significant rebound seen in equities since March has started to show signs of exhaustion in recent sessions. Equities have failed to hold gains against a backdrop of generally positive economic data. Bond yields have fallen back in recognition of the benign inflation/low interest rate outlook ahead. Oil and other commodities have drifted lower and risky currencies "“ which broadly continue to follow equity markets "“ have shuffled sideways as investors ponder the sustainability of the economic recovery and the extent of equity gains. Recent equity rises have taken P/E ratios up to what look like fully-priced levels "“ the S&P 500 has reached highs not seen since 2004. In short, an equity market correction is widely seen as needed, with talk of a 5% to 10% slide commonplace. An environment of top-heavy stocks should be reasonably USD supportive and the USD has, in any case, recently shown signs of rising when US data surprises to the upside. However, with investors generally surprised by the resilience of equities in recent months, and global data tending to be generally supportive, we suspect investors will be keen to sell USD on bounces. All up, we're expecting the USD Index to continue trading choppily within a 77.50-79.50 range over the coming weeks. We continue to think EUR/USD will struggle towards 1.4400-1.4450 and would view dips towards 1.4050 as a buying opportunity. * Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Capital team of economists is available here.