By BNZ Currency Strategist Danica Hampton

The NZD/USD has plunged dramatically over the past 24 hours, from around 0.6250 yesterday afternoon to below 0.5800 last night.

The carnage started last yesterday afternoon as fears about a global recession took a heavy toll on Asian equity markets. The Nikkei fell 9.4%, its largest daily loss since 1987, which triggered heavy selling of growth sensitive currencies like AUD and NZD against JPY. The NZD selling appeared to be triggered by Japanese margin accounts, but soon became more widespread. AUD/JPY plunged more than 10% and NZD/JPY dropped 9%.

The heavy NZD/JPY supply dragged NZD/USD through Monday's 0.6170 low and saw the local currency sink to 0.5785 "“ its lowest level since September 2003.

However, the NZD/USD rebounded off its lows as central banks around the world (including the Fed, ECB, Bank of England, Riksbank and the Bank of Canada) cut interest rates 50bps in unison. The unprecedented central bank action provided a bit of a boost to US equity markets. The S&P500 is currently up 1.65% and this has helped NZD/JPY recover and NZD/USD sprang back above 0.6100.

Locally, everyone is questioning whether or not the RBNZ follow its international counterparts and cut interest rates intra-meeting. Certainly, last night's coordinated central bank action raises the risk of such a move. Current market pricing suggests it's a 50:50 call on whether the RBNZ cuts 75bps or 100bps at its next meeting on October 23 and is consistent with another 50bps rate cut in December.

While the knee-jerk reaction to an intra-meeting RBNZ rate cut would likely see NZD/USD drop, we expect dips towards 0.5800 will attract buyers and solid support is expected ahead of the overnight low of 0.5785.

Given the speed and magnitude of the recent descent in NZD/USD, some consolidation is expected in the near-term. Any further rebound in investor confidence and stabilisation in global equity markets should help provide a bit of support for NZD/USD. While some headwinds are expected around the 0.6170-0.6200 region near-term, the NZD/USD has the potential to push back towards 0.6400-0.6450 in the coming sessions.

Nonetheless, against a backdrop of slowing NZ growth, expectations of RBNZ rate cuts and deteriorating NZ terms of trade should ensure bounces are limited to the 0.6400-0.6450 region.

It was another wild night across global financial markets.
Early on in the night, fears about a global recession and heavy losses in Asian and European equity markets, saw growth sensitive currencies like AUD and NZD sold heavily against the JPY. In Asia, the Nikkei dropped 9.4% - its biggest daily loss since 1987, the Hang Seng fell 8.2% and the Australian All Ords dropped 4.96%. European markets didn't fare much better, with the FTSE falling 5.2% and the German DAX fell 5.88%.
Liquidation of JPY cross positions held by Japanese margin traders appeared to trigger the move, but the selling became widespread. AUD/JPY fell 10%, NZD/JPY skidded 9% and USD/JPY fell from around 101.50 to nearly 98.50.
In response to the financial melt-down (and the risks it causes to global growth), central banks around the world cut interest rates in unison last night.

•  The Fed cut 50bps to 1.50%, the Bank of England cut 50bps to 4.50%, the ECB cut 50bps to 3.75%, the Riksbank cut 50bps to 4.75% and the Bank of Canada cut 50bps to 2.50%.
•  China cut its benchmark lending rate 27bps to 6.93%, the Swiss National Bank cut 25bps to 2.50% and the Bank of Japan confirmed its support for the co-ordinated action.
•  The accompanying statement justified the move by saying "the recent intensification of the financial crisis has augmented the downside risks to growth" and has "diminished further the upside risks to price stability".

The unprecedented central bank action provided a bit of a boost to US equity markets. The S&P500 is currently up 1.65% and this has helped USD/JPY and JPY crosses stabilise. However, investors are still uncertain how to weigh up the good news "“ the lower cash rates around the world "“ against the growing realisation that the central bank action may be insufficient to free-up global credit markets and a global recession may be difficult to avoid.

The UK Government also announced a rescue package for the financial sector, starting with a GBP25b capital injection and doubling the cash available through the special liquidity scheme. However, worries about how the finance package will be financed and concern about the deteriorating UK fiscal position added to the weight on GBP/USD.

* Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Markets team of economists is available here.