Opinion: NZ$ below 72.5 USc on global recovery fears; Markets reduce OCR hike expectations

By Mike Jones The NZD was the worst performing currency last week. Having started the week on a solid footing, a rapid unwinding of investors' risk appetite late in the week saw NZD/USD slip back to around 0.7250. "˜Growth-sensitive' currencies like the NZD underperformed on Friday night as risk aversion continued to creep higher. US equities were weighed down by disappointing earnings results from Dell and D.R. Horton. Meanwhile, a speech by ECB President Trichet took a toll on European equity markets. Trichet confirmed the ECB will begin to wind back some of its liquidity measures to ensure its inflation target is met. The S&P500 and the FTSE fell 0.3%, while the DAX was down 0.7%. More generally, it appears last week's mixed batch of data, combined with various warnings from officials that the path to recovery won't be all plain sailing, has seen fears about the strength and speed of the global recovery return. US equities fell by 1.7% over Thursday and Friday and risk appetite was knocked off its highs. As a result, the USD and the JPY were the strongest performing currencies as investors rushed back into "˜safe-haven' assets. In contrast, heavy selling by both model and speculative accounts took a toll on both NZD and AUD, and NZD/USD finished the week down 2.6%. A reassessment of monetary policy expectations also weighed on NZD and AUD last week. Australian markets significantly reduced the pace of tightening expected from the RBA. Locally, markets now expect 140bps of RBNZ tightening by September, down from 170bps at the beginning of the week. Thursday's NBNZ business survey will be the big focal point this week. While the improved dairy payout will no doubt help, we wonder if broader reservations about the strength and sustainability of the recovery are beginning to creep into the NZ business sector. Aside from that, Monday's migration report should show further steadying of net immigration. And October's credit aggregates should be considered key, as we know the RBNZ is following them very carefully. Despite last week's sharp falls in the NZD, nothing has really changed on the fundamental front. At 54%, our risk appetite index (which has a scale of 0-100%) remains above the long-run average of 50%. Meanwhile, our short-term valuation model (which is based on commodity prices, NZ-US interest rate differentials, global growth expectations, and risk appetite) suggests a "˜fair-value' range in NZD/USD of 0.7300-0.7500. All up, this suggests the NZD should again head higher at some point. However, momentum has clearly shifted to the downside for now, and many are wary of taking positions in "˜risky' currencies ahead of month-end and the US holiday on Thursday. If the current dour sentiment continues to hang over global equity markets we wouldn't rule out a deeper correction in NZD/USD towards 0.7080. Risk aversion was again the dominant theme in currency markets on Friday night. As a result, "˜safe-haven' currencies like the USD and JPY were the strongest performers. Over the latter part of last week, fears about the strength and durability of the global recovery resurfaced. These fears were driven in part by a sense the future pace of global growth will not be able to sustain the current rally in equity markets and "˜risky currencies'. The somewhat mixed nature of recent data certainly has not helped in this regard. Meanwhile, valuation metrics suggest equity markets are looking overstretched (the S&P500 P/E ratio is sitting at 22). On Friday, US stocks posted modest falls (the S&P500 was down 0.3%) as earnings reports from Dell and D.R. Horton fell below market expectations. A speech from ECB president Trichet did nothing to help sentiment. Trichet said the ECB will begin to remove its liquidity measures to ensure it doesn't fuel inflation. Market rumours about the Ukraine defaulting on its debt also did the rounds on Friday (but were later quashed). All of these developments served to dampen investors' appetite for risk, increasing demand for "˜safe-haven' currencies like USD and JPY. Indeed, 2-year US Treasury yields fell to the lowest level this year on Friday (of 0.67%) as safe-haven flows picked up. The broadly stronger USD saw most of the major currencies lose ground on Friday. EUR/USD fell to within a whisker of 1.4800, with rumoured optionality at this level noted as preventing further falls. GBP/USD was knocked back to 1.6500, having scaled 1.6850 early in the week. "˜Growth-sensitive' currencies like AUD, CAD and NZD tended to be hit the hardest as the reassessment of risk appetite took a toll of commodity prices. All posted weekly falls of close to 2%. Despite the holiday shortened week in the US (Thanksgiving is on Thursday), US data are likely to capture the most attention for the week ahead. US Consumer confidence, Case-Shiller house prices, Q3 US GDP revisions and the FOMC minutes are likely to be the highlights. However, the German IFO index for November and UK Q3 GDP revisions will also be interesting. All up, we suspect dips in the USD index will be limited this week given the backdrop of heightened risk aversion and profit taking ahead of month-end and US Thanksgiving. However, the fundamental picture for the USD is still not strong; the Fed is unlikely to move on rates anytime soon and Treasury yields are hitting record lows. As a result, a push on the USD index above 77.45 looks unlikely in the short-term. * Mike Jones is a BNZ Currency Strategist. All of the research produced by the BNZ Capital team of economists is available here.