Double Shot Interview: HiFX's Dan Bell reviews the week's currencies turmoil

Bernard Hickey talks with HiFX Senior Dealer Dan Bell about the week's currencies turmoil, including the New Zealand dollar's slump from a record high of 88.4 USc on Monday to under 82.7 USc on Friday as market fears of a US economic downturn turned to panic amid a worsening of Europe's sovereign debt crisis.

Bell was speaking after the Dow's 512 point plunge on Friday morning and ahead of US jobs figures due early on Saturday morning.

"Last night we saw a massive bout of risk aversion hit the US markets with the S&P and the Dow Jones both down over 4%. That's one of the biggest falls the US equity markets have ever had," he said, pointing out this was also reflected in lower commodity prices and a fall in 'risk averse' commodity currencies such as the New Zealand dollar.

"In the space of four days you've seen the US dollar lose almost 7% against the US dollar, which is pretty remarkable," he said.

Weak US manufacturing data and poor jobs figures in recent weeks had caused economists to start forecasting a double dip recession in the world's largest economy.

Bell noted intervention by the Swiss National Bank and Bank of Japan to drag their currencies back from record highs vs the US dollar this week.

Markets would now focus on the prospects for a third round of quantitative easing (QE III) or money printing from the US Federal Reserve. Its Federal Open Markets Committee, which sets monetary policy, is set to meet early next week and announce its decision next Wednesday morning at 6.15 am NZ time..

Bell cited comments from three senior Fed officials in a Wall St Journal article about the prospects for a third round of quantitative easing as a factor in markets this week.

Here's former Fed official Donald Kohn cited in the article:

Kohn said the Fed still has some options to support the economy, but “they’re kind of limited”. He expects the central bank, which holds a policy meeting Aug. 9, to wait and see whether the recovery is really losing steam before taking any action. If that’s the case — and inflation is coming down — then he’d give “very serious consideration” to a new round of bond purchases.

The bond purchases can help the economy by keeping borrowing rates, which are tied to U.S. Treasurys, low and by driving investors to riskier assets like stocks. But they’ve been attacked by Republicans at home and foreign government officials for fear they’ll spark runaway inflation and have lead the U.S. dollar to lose too much value.

"That gave a little bit of support to the equity markets yesterday morning. The markets are all thinking that perhaps it's time for Ben Bernanke and his team to get the printing press out and start flooding the world with US dollars again," Bell said.

Bernanke is due to meet with other central bankers, including our own Reserve Bank Governor Alan Bollard, from August 26 at Jackson Hole in Wyoming. Bernanke announced his QE II policy at last year's meeting.

'Criticism of ECB'

The European Central Bank bought Portugese and Irish bonds on Thursday night, but has been criticised for not buying Spanish and Italian bonds to contain a rout on those debt markets.

"The analysts are looking at the ECB's game plan over the last few months -- they've been raising interest rates -- and their whole strategy seems to be quite odd given the pressure that the peripheral European economies have been under."

(Updated: Later on Friday night Italy pledged to return its budget to balance a year earlier than expected, prompting the ECB to pledge to buy Italian bonds. Official also said it would buy Spanish bonds. This helped stem a rout on European markets late on Friday. See more here at Reuters.)

Australian sales weak

Retail sales figures in Australia were softer than expected this week and the Reserve Bank of Australia held interest rates with a dovish statement that is seeing markets across the Tasman begin to price in a rate cut later in the year.

The New Zealand dollar rose to a 12 month high of around 80.7 Aussie cents after those weak Australian retail sales figures, but it fell back under 80 cents late on Friday.

Overnight on Friday/Saturday markets would focus on US jobs figures.

US non-farm payrolls are expected to show around 85,000 new jobs added in July with a steady unemployment rate of 9.2%. Figures out late on Friday showed non-farm payrolls rose 117,000 and the unemployment rate fell to 9.1
%. See more here at Reuters)

"If it comes in worse than expected you'd expect the US equity markets to fall and the New Zealand dollar would probably follow that lower, as everyone looks to take leverage out of the market and unwind 'risk-on' positions."

"We could see another leg lower in this New Zealand dollar before it settles down."

(Updated: Early on Saturday Standard and Poor's downgraded America's credit rating to AA+ from AAA. See more here at Reuters.)

'Will the RBNZ really hike?'

Earlier this week markets and economists were confident signs of a strengthening New Zealand economy would prompt the Reserve Bank to hike the Official Cash Rate by 50 basis points on September 15. But this week's events have softened those expectations.

"Everyone is going to start to second guess that and question the wisdom of raising interest rates with the global backdrop deteriorating over the last week and the last few months. I see this morning the underlying market pricing for a hike in September has been reduced," he said.

(Updated with Jobs figures, S&P's downgrade of America's credit rating and ECB plan to buy Spanish and Italian bonds)

See our summary of the interest rate outlook here in The Crystal Ball.

Dan Bell is the Senior Dealer at HiFX, a UK-headquartered foreign exchange dealer with significant operations in Australia and New Zealand. It has a dealing room in Auckland. See more detail here.