Opinion: NZ$ falls to 71 USc as US$ strengthens on talk of US recovery

By Mike Jones The NZD suffered at the hands of a stronger USD and reduced appetite for risk last night. Having started the week around 0.7250, the NZD/USD is now closer to 0.7100. The USD surged to three month highs overnight. Not only did the FOMC statement and last night's Philadelphia Fed index confirm expectations for a gradual US recovery, but the USD also received a boost from increased "˜safe-haven' demand. Greece was downgraded by Standard & Poor's to BBB+ from A-, and this tended to weigh on investors' risk appetite. Global equity markets also retreated, in some cases sharply. The S&P500 is down around 1%, the FTSE fell nearly 2% and the Chinese Shanghai index slid 2.3% yesterday. Our index of risk appetite has fallen to 55%, from above 57% at the start of the week. Reduced appetite for risk and the stronger USD also weighed on commodity prices. Gold prices fell 3%, and oil prices dropped below US$72/barrel. Against a backdrop of the firmer USD and weakening risk appetite, NZD/USD fell from 0.7200 to a touch below 0.7100. This was despite yesterday's relatively solid NBBO business confidence survey. While confidence came off a bit further in December (+38.5 from +43.4 in November), the activity readings and expectations remained at least as solid as they were the month prior. Own-activity expectations, for example, rose to +37, from +34. And while employment intentions stabilised at around +6, and investment intentions at about +10, profit expectations rose 5 points to +16. Its worth noting, despite recent falls in NZD/USD, the "˜fair-value' range in NZD/USD implied by our short-term valuation model has remained relatively steady at 0.7300-0.7500. Commodity prices remain firmly on a upward trend, while NZ-US 3-year swap spreads are only 10bps below year-to-date highs. Nevertheless, we suspect NZD/USD will struggle to break out of its 0.7080-0.7300 range in the short-term. A convincing break below 0.7050 is needed to signal a deeper correction is on the way. Most of the major currencies lost ground against the USD overnight. The USD surged over 1% to three month highs above 77.50. Yesterday's FOMC statement did nothing to slow the rise of the USD. The Fed's key policy rate and asset purchase scheme were left unchanged. But, as expected, the Fed upgraded its assessment of the US economy, noting the "deterioration in the labour market is abating". Further evidence of a US recovery was provided overnight in the form of the Philadelphia Fed Index of factory activity. It rose to 20.4 in December, well above the 16.0 analysts had expected. The USD has also benefited from an increase in "˜safe-haven' demand over the past 24 hours. Indeed, the S&P500 is currently down about 1%. Citigroup's stock offering was met with muted demand and earnings from FedEx came in below expectations, both of which weighed on stock markets. Meredith Whitney (a prominent stock analyst) also cut earnings estimates for Goldman Sachs and Morgan Stanley. The VIX index (a proxy for investors' aversion to risk) rose from 20.50 to above 22.00. Reduced risk appetite and gains in the USD also took a toll on commodity prices overnight. Oil prices are down 0.7% and the broader CRB commodity price index recorded a 1% fall. Not even comments from the Deputy Governor of the People's Bank of China that the "USD depreciation will continue" were enough to slow gains in the USD last night. Against the broadly stronger USD, EUR/USD slid from 1.4530 to almost 1.4300. Standard & Poor's downgraded its rating on Greece from A- to BBB+, following a similar action from Moody's last week. Market chatter suggests traders also took advantage of holiday-thinned trading conditions to try and take out a rumoured EUR/USD option barrier at 1.4500. Once this was achieved, stop/loss orders were triggered and EUR/USD selling intensified. A shock fall in UK retail sales sent the GBP tumbling, heaping more support on the USD. November sales fell 0.3%, in stark contrast to expectations for a 0.4% rise. As a consequence, GBP/USD fell as low as 1.6100, more than 2c lower from where it started the night. Looking ahead, the Bank of Japan meeting today may garner some interest around the announcement of possible quantitative easing measures. Meanwhile, the German IFO survey and UK public finance data are likely to occupy markets' focus tonight. In the near-term, support on the USD index is eyed on dips towards 77.00. * Mike Jones is a BNZ Currency Strategist. All of the research produced by the BNZ Capital team of economists is available here.