A Fed decision to roll Operation Twist into Treasury purchases paves way for stronger NZ$ against US$

By Mike Jones

NZD

The relentless upward march of the NZD has continued over the past 24 hours. The NZD/USD broke through key resistance at 0.8360 overnight, as expected, and now trades at 9-month highs around 0.8385.

The gains in the kiwi mostly reflect investors’ risk seeking behavior following a cheerful night in global equity markets (see Majors).

Notable in this respect is the fact our risk appetite index (scale 0-100%) has crept up to 76%. But solid buying of NZD/AUD has also contributed to broad NZD strength. Indeed, the cross briefly flirted with 0.8000 overnight before slipping back to around 0.7965.

NZ-AU interest rate differentials have increased sharply (become less negative) in the wake of last week’s less-dovish RBNZ meeting. This has dulled the relative appeal of the AUD over the NZD.

Yesterday’s lacklustre NAB Australian business confidence survey continued the trend improvement in NZ-AU ‘fundamentals’. Confidence slipped from -1 to -9, the lowest since May 2009. Compare this to the broad improvement in business indicators we saw from the November ANZ NZ business confidence survey.

According to our short-term valuation model (based on relative business confidence, interest rate differentials, and commodity prices), ‘fair-value’ in the NZD/AUD is currently seen in a 0.8050-0.8250 range.

Along with positive momentum and a supportive technical picture, this points towards a likely return to the October highs in the cross around 0.8050.

For the NZD/USD, the convincing break above 0.8360 means the 2012 highs of 0.8475 now loom as the next target. However, the immediate fortunes of the NZD/USD rest with tomorrow morning’s FOMC meeting.

A Fed decision to roll Operation Twist into Treasury purchases (as we expect) would simply reinforce the USD weakness status quo, paving the way for additional NZD/USD gains.

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Majors

Improved European economic news, optimism over the US fiscal cliff, and the usual pre-FOMC ebullience has underpinned a more upbeat tone overnight.

Buoyant risk sentiment has seen equity markets rally, benchmark yields rise, and the ‘safe-haven’ USD and JPY underperform. The EUR and NZD have led the way in dragging the major currencies higher.

A surprise jump in the ZEW survey of German investor sentiment, to the highest level since May (+6.9 vs. -11.5 expected), has helped assuage fears of the German economy dipping into recession early next year (particularly when viewed alongside the solid IFO, PMIs and German factory orders data).

On the other side of the Atlantic, investors have taken heart from suggestions that progress is being made on the US fiscal cliff. Emerging evidence that some senior Republicans appear open to ceding some ground on Democrat aims to raise taxes on the wealthiest from 29.6% to 35% may have contributed here.

The expectation of more Fed-easing has likely further fuelled the rally. Fed-watchers have pointed out that US equity markets have rallied ahead of five out of the seven FOMC meetings this year.

At tomorrow morning’s meeting (6:30 NZT), we expect Operation Twist to be replaced with between US$25-45b of outright Treasury purchases per month (along with continued buying of mortgage-backed securities).

Additional Fed easing (some are calling it QE4), combined with a more general flight back into ‘risk’ assets should ensure gradual USD weakness continues.

Our momentum model is short the DXY index from 80.02 and has lowered its stop/loss to 80.66). We look for the EUR/USD to grind back up into a 1.3000-1.3200 range in coming sessions.

Other News:

*The US trade balance prints a shade better than expected in October (US$42.2 vs. US$42.7b expected).

*Speculation circulates that the SNB may raise the EUR/CHF floor from 1.2000 and/or introduce negative interest rates at Thursday’s meeting.

Event Calendar:

12 December: AU consumer confidence; AU RBA’s Stevens speaks in Bangkok; EU German CPI; UK ILO unemployment EU Eurozone IP; UK BoE’s Dales speaks; US FOMC decision;

13 December: NZ PMI; US PPIs; US retail sales; US jobless claims;

14 December: JN Tankan; CH HSBC flash PMI; EU PMIs; US CPI.
 

All its research is available here.