Opinion: Firmer US$ and Fonterra news nudges Kiwi$ lower; all eyes on the budget

By Danica Hampton After climbing above 0.6250 yesterday morning, NZD/USD has edged lower over the past 24 hours. The NZD came under a wave of selling pressure following yesterday's announcement of the Fonterra payout forecast for the 2009/10 season, which at NZ$4.55 is was well below the current season's NZ$5.20. Later in the afternoon, the NBNZ business sentiment survey suggested there were some signs of economic stability emerging from the rubble. There was some improvement in the headline sentiment index and the own activity indicators, although the detail suggests exporters are still feeling the pinch (understandable given the recent currency strength). While no one's particularly positive just yet, there are some signs the NZ business sector is coming back from the brink of collapse, similar to what we've seen in a lot of other economic indicators here and abroad over the past few months. Overnight, a generally firmer USD kept the downward pressure on NZD/USD. Solid demand at the US Treasury auction and doubts about global "green shoots" underpinned the USD last night. Soft German CPI data and comments from ECB officials highlighting the potential for further interest rate cuts weighed on EUR/USD. While US data showed a massive build-up of unsold homes, which combined with General Motors getting closer to bankruptcy saw US equities fall nearly 2%. Locally, the focus is now on the Budget. Last December's DEFU (which, even by Treasury's subsequent admission, contained forecasts that were spectacularly over-optimistic) expected bond issuance to reach 10% of GDP by 2012. The economic deterioration since the DEFU will surely be reflected in wider core deficits and even greater need for debt funding. It will be interesting to see how the government skirts the line between spending enough to stimulate the economy, while exercising enough restraint as to not alarm the ratings agencies by the deteriorating fiscal position (in light of NZ's huge current account deficit). We (and most others) believe Standard & Poor's will refrain from downgrading NZ's sovereign rating over the near term (having placed us on negative outlook back in January). However, Moody's and Fitch have NZ effectively a notch above S&P and on a stable outlook. It's not inconceivable that either Moody's or Fitch takes the opportunity to revise down their NZ ratings. Fundamentally, we continue to think NZD/USD looks over-stretched. However, currencies can deviate from economic fundamentals for substantial periods of time and USD sentiment will be key to NZD/USD's near-term fortunes. For today, the backdrop of a generally firmer USD should ensure bounces in NZD/USD are limited to 0.6250. Initial support is seen around 0.6140-0.6150, but a break below this level will open up the downside towards 0.6090. The USD edged higher against most of the major currencies last night, encouraged by firm demand at US Treasury auction and doubts about global "green shoots". The US Treasury 5-year government bond auction attracted solid demand, easing fears that the burgeoning fiscal deficit is souring demand for USD denominated debt. Last night's US$35b 5-year auction attracted bids for 2.32 times the amount of bonds on offer and the indirect bidders (often considered to be a proxy for foreign buyers) totalled 44%. The US economic data was a little mixed. The pace of existing home sales rose 2.9%m/m in April, but the inventory of unsold homes rose 8.8%. Worries about the glut of housing supply cast some doubts over the strength and timing of a US recovery. Meantime, General Motors took another step toward bankruptcy after announcing that insufficient bond holders have agreed to swap debt for company stock. The net result took a toll on Wall Street and the S&P500 is currently down 1.9%. Doubts about the global recovery and solid demand at the US Treasury auction helped underpin the USD. Against a generally firmer USD, EUR/USD slipped from around 1.4000 to around 1.3880. Soft German CPI data and comments from ECB officials also took a toll on EUR. ECB council member Liikanen said the ECB has not ruled out further interest rates cuts and should not set a floor for rates. ECB sources were quoted as saying the central bank could increase its program of buying covered debt if the proposed EUR60b provide insufficient. Despite the firmer USD tone, GBP/USD broke above 1.6000 for the first time in nearly 7 months. Receding pessimism about the UK economy and financial sector bolstered GBP and persist selling of EUR/GBP was noted throughout the night. Data from the British Bankers' Association showed the number of mortgage approvals rose 3.8% in April (although approvals remain down 15.5% on a year earlier levels). ____________ * Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Markets team of economists is available here.