There’s oodles of event risk for currency markets this week

By Mike Jones

The NZD spent most of last week flying high on buoyant global risk sentiment. The NZD/USD ended last week around 1.9% higher. Overnight, the currency continued to climb, this time to 3-month highs above 0.8130.

Some stabilisation in Europe’s debt crisis, receding fears about a “hard” landing in China (Chinese GDP beat expectations) and solid UK and European economic data all acted to bolster global growth sentiment last week. The MSCI World Equity Index rose 2.9% over the week and our global risk appetite index (scale 0-100%) soared from 47.4% to 57.3%.

Despite the positives from a brightening global backdrop, a shock drop in Thursday’s Q4 NZ CPI (-0.3% vs. market expectations of +0.4%) proved a thorn in the currency’s side. Domestic interest rates dropped precipitously on the release and NZ-US 3-year swap differentials (a measure of the NZD’s yield attractiveness) slipped from 240bps to 225bps over the week.

So how will the currency fare this week? Let’s have a quick look at the near-term drivers of the NZD/USD.

Fundamentals:
Undoubtedly, recent NZD/USD gains have outpaced ‘fundamentals’. Our short-term valuation model currently suggests a “fair-value” range of 0.7400-0.7700 in the NZD/USD.

Market Positioning:
The speculative community increased its net long position in the NZD from a net 5k contracts to a net 9.5k last week. This is a relatively large weekly move historically speaking. However, speculative positioning is nowhere near ‘extreme’. In fact, at 9.5k, net longs are currently bang-on the long-run average.

Momentum/Technicals:
Our momentum model is long NZD/USD, and will remain so while the currency trades above 0.7866. Technically speaking, last week’s daily close above the 200 day moving average was a positive signal and there is little resistance ahead of October’s 0.8240 high.

Putting it all together, NZD/USD ‘fundamentals’ are stretched but market positioning and momentum/technicals suggest room for further upside.

There’s oodles of event risk for currency markets this week. Not only internationally (see Majors), but domestically too. The key local focus will be Thursday’s RBNZ OCR Review. While the OCR will almost certainly be held at a record-low 2.50%, expect some softer rhetoric from the RBNZ. The currency is sure to come in for some attention too, given the NZ TWI is a whopping 7% above previous RBNZ predictions.

Majors

Having shown signs of stabilising on Friday, USD sentiment deteriorated overnight. This mostly reflected gains in the EUR/USD (the so-called “anti USD”).

Currency markets struggled for direction through most of Friday and Monday. Indeed, adjustments in speculative positioning trumped the limited news flow in driving currencies. After the EUR/USD failed to break above the key 1.3000 level on Friday, speculative and real money selling pushed the single-currency to a low of around 1.2890. In contrast, the GBP found some support from a solid December UK retail sales report (2.6%y/y vs. 2.4% expected).

However, overnight, the EUR/USD climbed steadily, regaining all of Friday’s losses. Firming European equity markets (the Euro Stoxx 50 rose 0.6%) and whispers a Greek PSI deal may be close helped bolster sentiment toward the EUR.

This week is chock full of events that could shape currency market sentiment. Most Asian markets are closed until at least Wednesday (Chinese markets are off all week) for Lunar New Year, but European and US events should easily fill the void.EU finance ministers are meeting today and tonight, while heads of state will meet later in the week.

Watch for any change in the speed or tightness of the rules towards the new European fiscal compact. European PMIs are due tonight with the all important German IFO survey to be released tomorrow evening.

A possible resolution to the Greek PSI debate is the big wildcard for the EUR this week. A positive outcome could see a further EUR/USD squeeze above resistance at 1.3100. However, a negative outcome would likely spur a larger, downside move in the EUR. Stagnant European growth and accommodative monetary policy mean EUR/USD rallies should be seen as selling opportunities, in our view.

Later in the week the focus shifts to the US. Thursday morning’s FOMC meeting will take centre stage, with a steady stream of US corporate earnings results and Q4 US GDP also worth watching. This will be the first FOMC meeting in which member’s interest rate expectations are shown, boosting the likelihood of a more violent than normal market reaction.

All up, we look for USD sentiment to stabilise at some point this week, once the EUR/USD short squeeze has run its course. But for this to pan out we’ll need to see the Fed downplay market hopes of more quantitative easing (QEIII) and further signs of sustained recovery in this week’s US data. Near-term support on the USD index is eyed on dips towards 79.5 with initial resistance at 80.6.

All its research is available here.