Opinion: Kiwi$ gets strong support from perceived RBNZ interest rate tightening cycle

By Mike Jones The NZD was the strongest performing currency last week. After mooching around a 0.7050-0.7180 range for most of the week, the RBNZ statement on Thursday provided the NZD with fresh impetus for a gallop back towards 0.7300. Not only did the RBNZ paint a positively rosy outlook for NZ, but it is now forecasting the first hike in June next year (from the earlier-signalled December). In reaction, market participants have priced in a much more aggressive tightening track. Contrary to Governor Bollard's view that the market had overreacted, we think the reaction was entirely expected given the messages. On Friday night, broad strength in the USD was the main theme in currency markets. US data reassured investors the US consumer is still alive and well. Retail sales rose at twice the expected rate in November (1.3% vs. 0.6% forecast) and consumer confidence also positively surprised (73.4 vs. 68.8). The upbeat data saw markets continue to bring forward the timing of the first Fed rate hike, which underpinned the USD, despite a further improvement in risk appetite (global equity markets posted modest gains). Against the broadly stronger USD, NZD/USD eased off highs around 0.7300, to finish the week closer to 0.7250. We suspect the various local data offerings for the week ahead will broadly fit with our view the NZ economy is on a recovery path. Given the Reserve Bank's evident jitters around the housing market, November's REINZ figures, rumoured to be due this morning, should be keenly watched. The key question will be whether the increase in listings we expect is underway is weighing on prices. Thursday's NBNZ survey results should continue to signal reasonable growth in the months ahead, while the Government's half-yearly update will likely depict a withering tax base. Note that the headline retail trade figures for October have already been released, inadvertently, with the earlier electronic card transactions, further detail and commentary will be released today. All things considered, we suspect the NZD will remain well supported over the week ahead. The RBNZ has effectively provided markets with the green light to price an earlier start to the RBNZ tightening cycle. Indeed, the post-RBNZ sell-off in interest rates has seen NZ-US 3-year swap spreads surge to nearly 350bps "“ their highest level since October 2008. This has seen the lower bound of our short-term "˜fair-value' model move up from 0.7150 to nearly 0.7400, suggesting dips below 0.7200 are unlikely to be sustained. However, with US markets now expecting an earlier start to Fed tightening, and a bit of year-end profit taking setting in, we suspect the NZD will struggle to break its year-to-date high of 0.7630 before year-end. Short-term resistance is eyed around 0.7330. The USD strengthened against all of the major currencies on Friday night as upbeat data boosted confidence about the US economic recovery. Developments in currency markets on Friday provided further evidence that risk appetite may be fading as a driver of the USD. The November advance US retail sales report showed sales surged 1.3% during the month, over twice the 0.6% expected. Meanwhile, according to the University of Michigan survey, consumer confidence rocketed to 73.4 in December (analysts had expected 68.8). Combined with last week's surprisingly good employment report, the data increased investor confidence in the sustainability of the US recovery, sending US interest rates higher. US 2-year Treasury yields rose 5bps as talk of an earlier start to Fed tightening continued to circulate. 10-year Treasury yields hit the highest level since August at one point, but finished the night 5bps higher at 3.55%. Global equity markets generally advanced on Friday night, encouraging investors' risk appetite. Asian stocks found support from another solid batch of Chinese data, in particular a 19.2%y/y gain in November industrial production. The Nikkei rose 2.5% and the Hang Seng was up 0.9%. The positive sentiment continued into European and US markets, helped by the upbeat US data. The DAX rose 0.8% and the S&P500 edged 0.4% higher. However, despite the gains seen in equities and risk appetite, it was the rise in US interest rates that tended to drive the USD on Friday night. In fact, the USD index rose nearly 1% to the highest level in over a month. As a result, all of the major currencies came under pressure. EUR/USD dipped below 1.4600 for the first time since October, while USD/JPY rose to nearly 90.00. In contrast, GBP was relatively insulated from the USD strength after ratings agency Moody's said the UK's AAA rating is not under immediate threat. We suspect that relative growth prospects and diverging economic fundamentals will have a greater role to play in driving currencies in 2010. This means we may actually start to see the USD benefit from upside surprises in US data rather than falling due to rising risk appetite. The next key test for the USD though will be the FOMC rate decision on Thursday morning. Recent moves in market pricing suggest some change in language will be needed from the Fed for the USD to hold onto recent gains above 76.00. Also this week, US housing starts, building permits, industrial production and the Philadelphia Fed index will shed further light on the US outlook. Australian Q3 GDP, UK retail sales and the Bank of Japan meeting will also be worth watching. * Mike Jones is a BNZ Currency Strategist. All of the research produced by the BNZ Capital team of economists is available here.