Opinion: Why the NZ$ fell to a 2 year low

By BNZ Currency Strategist Danica Hampton The RBNZ surprised all and sundry by slashing the cash rate by 50bps to 7.50% yesterday. While our economists concur with the central bank's broader economic outlook and its desire to see interest rates lower, the communication surrounding yesterday's policy decision left a lot to be desired and probably created a bit more market volatility and confusion than was necessary. Nonetheless, yesterday's larger than expected OCR cut paved the way for widespread NZD selling. NZD/AUD skidded from above 0.8300 to below 0.8150 last night as many macro accounts were wrong-footed by the RBNZ decision. Yesterday's stronger than expected Australian jobs data (jobs grew 14,600 in August and the unemployment rate dipped to 4.1%) and last night's relatively hawkish AFR article from noted RBA watcher Alan Mitchell also added to the downward pressure. The slide through 70.00 in NZD/JPY triggered a wave of stop-loss selling from Japanese margin accounts. While lingering concerns about sustainability of Lehmans and the fragility of the financial sector saw NZD/JPY extend its losses to nearly 68.50 last night. Against a backdrop of a generally firmer USD, heavy selling of NZD crosses saw NZD/USD slide to around 0.6440 last night "“ its lowest level since September 2006. NZD/USD rebounded off its lows towards the end of the NY session as vague rumours, about the possibility of another Fed interest rate cut and that Bank of America was considering buying a stake in Lehmans, triggered a strong bounce in US stocks. For today, worries about a global slow-down, a NZ recession and expectations about further RBNZ rate cuts should ensure bounces are limited to the 0.6540-0.6560 region. Initial support is seen around 0.6440, but the risks look skewed in favour of a deeper correction in coming sessions. Majors The now familiar themes of a stronger USD and weaker JPY crosses dominated currency markets again last night. USD/JPY sank from above 107.50 to almost 106.00 last night, while EUR/USD tumbled to nearly 1.3880 - its lowest level since September 2007. Over the past few weeks, the USD has been bolstered by evidence that growth elsewhere in the world is slowing more sharply than that in the US. Not only was UK Q2 GDP revised lower (from +0.2%q/q to zero), but activity indicators in Germany, France and Italy disappointed in August suggesting Eurozone growth is on track to contract again in Q3. Last night, ECB council member Wellink noted that a "technical recession" cannot be ruled out in the Eurozone. Meanwhile, investors also worry that instability in the financial sector will hurt the global economy as mounting mortgage losses restrain bank lending. Shares of Lehman tumbled more than 40% as investors worried about its inability to raise capital and questioned its survival. Stocks of three other major US financial institutions, AIG, Merrill Lynch and Washington Mutual also suffered double digit losses last night. Escalating concern about the global growth outlook and the health of the financial sector has taken a heavy toll on global equities and risk appetite, which has encouraged selling of higher yielding, growth sensitive currencies like NZD against 'safe-haven' currencies like JPY. Since the beginning of September, the MSCI world equity index has fallen 7% and our risk appetite index (which has a scale of 0-100%) has dropped 12% to 41%. A retreat in crude oil prices also provided a bit of support for the USD. Despite OPEC suggesting it would cut its production quota earlier in the week, crude oil prices edged to nearly US$100/barrel last night amid worries about slowing global demand. As worries about slowing global growth resurface, we expect the USD to remain well supported. Inflation trends and interest rate differentials have ceased to be the primary driver of currencies over recent months. Instead, the prospects for real economic growth, portfolio investment and FDI flows have gained importance. With the US authorities pursing relatively pro-growth monetary and fiscal policies, the prospects for US growth are arguably more promising than elsewhere in the world. Not to mention, after watching the USD fall for seven years, real money investors and corporates are heavily under-weight USD * Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Markets team of economists is available here.