NZ dollar meanders as markets focus on European debt worries

By Mike Jones

It’s been a fairly lacklustre start to the week for the NZD. The NZD/USD has spent most of the past 24 hours mucking about in a tight 0.6700-0.6800 range.

The NZD enjoyed some fleeting support yesterday from a modest recovery in Asian stock markets. Most notably, the Shanghai Composite index rose 3.5% (but is still down almost 7% for the month to date) on the back of reports China is slowing the implementation of property taxes in response to recent concerns about global growth. Easing fears about a slowing in Chinese demand also provided a boost to commodity prices.

The CRB index (a broad index of global commodity prices) was up almost 1% at one point yesterday afternoon, helping underpin NZD/USD’s brief push towards 0.6800. However, the NZD/USD was unable to extend its gains overnight. Markets’ focus quickly returned to the EUR and the headwinds the European sovereign debt crisis poses for the global economic recovery. The EUR/USD resumed its slide and global stocks either flat-lined or fell.

All in all, it wasn’t a very supportive backdrop for a ‘growth-sensitive’ currency like the NZD, and NZD/USD soon found itself sliding back towards 0.6750. Historical economic data are clearly taking a back seat to financial market turbulence at the moment.

And this week’s NZ batch of data is not top-tier in any case. As such, the global backdrop will remain the most important driver of the NZD/USD this week. In this regard, keep a close eye on equity markets and commodity prices as the key gauges on the extent to which Europe’s debt crisis is spilling over into wider concerns about global growth. Further falls would pose clear risks to the robust global recovery most expect.

All up, we suspect some consolidation is due for NZD/USD this week. While the recent cautious improvement in risk appetite bodes well for further recovery in NZD/USD, we suspect a push through 0.7000 will be a bridge too far in the near-term given the headwinds from still fragile sentiment and negative momentum.

Majors

The USD strengthened against most of the major currencies overnight. The return of EUR weakness was the main theme of the first part of the night. With last week’s mild ‘short’ squeeze out of the way, the EUR was once again dragged lower by sovereign debt worries. The Bank of Spain’s weekend takeover of small savings bank CajaSur served up a reminder of the fragility of parts of the Eurozone banking sector.

Meanwhile, comments from EU Commission President Barroso highlighted European leaders’ generally disjointed and uncoordinated approach to tackling the crisis. Barroso said "It would be naive to think one can reform the treaty only in areas Germany considers important." EUR/USD slid from 1.2550 to almost 1.2350. European stocks put in a similarly lacklustre performance, partly attributable to holiday-thinned liquidity.

The DAX dipped 0.4%, the FTSE ended around flat and the Spanish IBEX slumped 2.6%. While the sliding EUR set the early foundations for a strengthening in the USD, the trend was reinforced later in the night by more evidence of the solid US economic recovery. US existing home sales rose 7.6% in April, to five month highs (5.1% expected). However, it’s worth noting that part of the gains reflects a scramble to buy before the end of the US homebuyer tax credit. Despite the stronger data, US stocks put in mixed performance.

The S&P500 is currently down 0.6% and the NASDAQ is close to flat. Sentiment towards GBP received a welcome boost from British Finance Minister Osborne’s first instalment of UK spending cuts. Osborne announced £6.25b worth of cuts, with the promise of more to come in June’s ‘emergency’ budget. While not great for the UK economy, cuts are drastically needed to trim the UK’s whopping budget deficit and avoid a sovereign ratings downgrade. While GBP struggled to make any headway against the stronger USD, EUR/GBP tumbled from 0.8680 to nearly 0.8580.

Looking ahead, we suspect contagion risks from the European sovereign debt crisis will remain front-brain for markets. So, in this vein, keep an eye on equity markets and the EUR for a gauge on how sentiment is progressing.

With negative momentum firmly engrained, we wouldn’t be surprised to see EUR/USD re-test recent lows around 1.2200 in coming sessions. Data developments will probably remain off the radar, even more so this week given the lack of any heavyweight data. A swathe of US housing data and the 2nd estimates of US and UK Q1 GDP (both are expected to be revised higher) will probably be the highlights.

* Mike Jones is part of BNZ's economics and markets research team. More BNZ research is available here.