Kiwi dollar outlook uncertain as Euro fears drag on sentiment

By Mike Jones*

Easing risk aversion saw sentiment towards the NZD stabilise overnight. The NZD/USD has spent most of the past 24 hours consolidating in a 0.6580-0.6680 range.

Overall, there was relatively little new direction for currency markets overnight. Most of the major currencies simply chopped around inside their recent ranges. Still, the lack of any further “bad” news out of Europe and some encouraging comments from US Fed Chairman Bernanke helped assuage market fears about the strength of the global recovery.

Bernanke noted that momentum in the US economy is such that a ‘double-dip’ recession is unlikely. With risk appetite stabilising, and Asian equity markets posting gains of 0.2-1.2%, sentiment towards “growth-sensitive” currencies like the NZD and AUD improved.

Amid solid demand from sovereign and real money accounts, NZD/USD climbed from sub-0.6600 to an overnight high of close to 0.6670. Nevertheless, resistance around 0.6680 proved too great a hurdle for NZD/USD given ongoing concerns about European sovereign solvency (rumours did the rounds last night a European bank was in trouble) and another lacklustre night in European equity markets.

There’s no doubt that the outlook for the NZD has become a lot more uncertain in recent weeks.

Mounting concerns Europe’s debt crisis will evolve into the global credit crisis version 2.0 have completely side-swiped investors’ appetite for risk.

As a result, fundamentals have largely gone out the window, with equity market sentiment becoming the major driver of the currency. Indeed, the correlation between the S&P500 and NZD/USD has increased from around 40% in mid-April, to closer to 85% currently.

While we remain of the view positive NZD fundamentals will eventually see NZD/USD push higher, negative momentum looks well engrained for now and heightened risk aversion suggests the NZD will remain heavy. The key level to watch is May’s low of 0.6560. A daily close below this level would pave the way for a deeper correction towards 0.6400.

Majors

The USD weakened against most of the major currencies last night. Still, most of the majors remained confined to recent ranges and the USD index is only a touch below 15-month highs. After being repeatedly battered over the past week, investors’ risk appetite stabilised yesterday following a speech from US Fed Chairman Bernanke. Bernanke said the US economy has enough momentum to avoid a double-dip recession and European leaders are committed to the survival of the EUR.

Asian stocks posted small gains and investors trimmed “safe-haven” positions in the USD and JPY as sentiment towards the EUR and “growth-sensitive” currencies improved. The VIX index (a proxy for risk aversion) edged lower from 36.5% to 36.0%.

The EUR managed to briefly extend its gains following a surge in EUR/CHF. After falling to fresh all-time lows below 1.3750, EUR/CHF jumped to nearly 1.3900 amid rumours of intervention by the Swiss National Bank (who has previously said it will act to prevent “excessive” CHF strength). European Finance Ministers made all the right noises after their latest meeting (more needs to be done in containing the debt crisis etc.), which may have also helped prop up EUR sentiment last night.

However, the cautious improvement in sentiment faded somewhat over the latter stages of the night.

Not only did European stocks put in another lacklustre performance (falling 0.6-0.8%), but European sovereign solvency fears reared their head again. Market chatter suggested a European bank may be in trouble and Spanish public service workers staged a 1-day strike against Spanish austerity measures.

The EUR/USD slipped from above 1.2000 to around 1.1920, paving the way for a small rebound in the USD. GBP was the most obvious weak spot amongst the majors. The UK’s AAA rating returned to the spotlight for all the wrong reasons after ratings agency Fitch said the UK was facing a “formidable” fiscal challenge. After grinding up to above 1.4500, GBP/USD was quickly slammed back below 1.4400. Looking ahead, we suspect equity market sentiment will remain the dominant driver of currencies in the short-term.

Not only are investors trying to figure out to what extent Europe’s debt problems will affect the global economy, but worries are mounting about a slowing in Chinese growth. We’re unlikely to get any firm steer on the former issue this week, but an update on the latter will come in the form a slew of Chinese data due over the next few days.

Policy announcements from the ECB and BoE, US retail and consumer confidence data, and Australian employment data will also be worth watching.