Opinion: NZ$ firms slightly; in holding pattern ahead of RBNZ decision

By Danica Hampton NZD/USD rebounded last night, climbing from yesterday's low of nearly 0.6160 to within a smidgen of 0.6300. The key theme in currency markets was USD weakness. Risk appetite improved following news that 10 US banks were given approval to repay funds borrowed from the US government under the TARP scheme. Markets ignored weaker than expected German export and industrial production data. Instead a "buy EUR/USD" recommendation (from a US investment bank) coloured sentiment and EUR/USD surged from below 1.3900 to nearly 1.4100. Against a backdrop of a generally weaker USD and improving risk appetite, NZD/USD pushed higher. However, NZD tended to lag a bit against the crosses as investors have little appetite to add to NZD positions ahead of tomorrow's RBNZ decision. We've been talking about a short-term USD recovery for quite a few days now, and last night's slide in the USD begs the question "is the USD recovery already over?" We're not yet convinced and are watching the USD Index for guidance. Provided the USD Index stays above 79.00, we'll think the USD will stay in recovery mode. Against this backdrop, we'll continue to view NZD/USD bounces as a selling opportunity, particularly ahead of tomorrow's RBNZ decision. For today, we expect bounces will be limited to the 0.6325-0.6350 region. Initial support is seen around 0.6230, but a break of this level will open up a deeper correction towards 0.6160-0.6170. Yesterday's Q1 construction data was a nowhere near as bad as feared (falling just 0.7%q/q vs. our -8.0% pick). While the upward surprise in construction has seen us revise up our Q1 GDP forecast to -0.7%q/q (from -0.9%), we've pushed the weakness into Q2 (our Q2 GDP forecast is currently sitting at -0.2%). Further clues on Q1 GDP will come from today's terms of trade release. We're looking for a drop of 0.8%q/q (slightly above market forecasts for a -3.8% decline) as we think the negative dairy story will be offset by gains in oil exports. The USD weakened against most major currencies last night amid improving risk appetite and a drop in short-dated US bond yields. EUR/USD bounced from nearly 1.3850 to 1.4100 and GBP/USD surged from 1.6000 to around 1.6350. Recovering risk appetite undermined the USD. US Treasury Secretary Geithner confirmed that 10 of the US banks that borrowed TARP funds from the US government had approval to repay loans totalling around US$68b. Geithner (and it seems investors) was comforted by the "encouraging signs of financial repair". The S&P500 is currently up 0.52%. Meantime, short-dated US bond yields fell and this added to the weight on the USD. Investors are starting to question whether or not the Fed will actually tighten rates before the year is out. US 2-year government bond yields fell 9bps to 1.30% and the yield curve steepened (10-2 spread rose from yesterday's low of 2.46% to 2.56%). Markets shrugged off weaker than expected German export and industrial production data. Instead, a US investment bank's "buy EUR/USD" recommendation probably helped underpin the EUR. In the UK, Prime Minister Brown seems to have a more comfortable hold on power and the reduced uncertainty helped lift GBP. So what does it all mean? Regular readers will know we've been looking for a near-term bounce in the USD as some of factors behind the recent slide (risk appetite, market positioning and inflation expectations) were looking stretched. This didn't alter our longer term view that the USD will remain heavy over the coming quarters "“ thanks to long-term issues (like the burgeoning US fiscal deficit and reserve diversification) bubbling away in the background. More it was case of the USD Index failing to take out key support in the 78.00 region last week and so we were looking for a move back towards 82.00-82.50. The USD Index climbed above 81.50 yesterday, but slipped below 80.00 last night. Does this suggest the USD's recovery is already over? Perhaps, but we're not yet convinced it's ready to embark on a new period of weakness. It'll take a move below 79.00 on the USD Index (and above 1.4200 in EUR/USD) to convince us we're wrong and the USD Index is in for at least heading for another test of 78.00. Providing EUR/USD doesn't breach 1.4200, we'll remain in a "sell on rallies" mode and look for a slide back towards 1.3700. ____________ * Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Capital team of economists is available here.