Opinion: NZ$ buffeted by Russian bank talk on diversifying reserves

By Danica Hampton It's been another rollercoaster night for NZD/USD, which has spent the past 24 hours in a 0.7130-0.7230 range. Early in the night, NZD/USD was dragged above 0.7200 on the coat-tails of the AUD/USD. The AUD surged higher after headlines suggested the Russian central bank was planning to diversify its foreign reserves into AUD and CAD. However, the initial headlines proved to be misleading. The Russian central bank actually said it couldn't diversify into AUD and CAD because of liquidity constraints. The Russian central bank went on to say it was planning to keep the proportion of its USD-denominated reserves steady at about 30% and bemoaned the fact that "realistically, currency reserves can't"¦ be significantly diversified". As investors digested the Russian central bank's actual comments, the USD tended to strengthen broadly and the NZD/USD was knocked from its highs. Weak US consumer confidence data, mixed global equity markets and a tsunami warning (following an earthquake in Samoa) did little to help NZD sentiment. NZD/GBP skidded from just under 0.4550 to sub-0.4480 last night. GBP strengthened sharply after the Bank of England told economists it was unhappy with the way the currency market reacted to last week's comments from Governor King, and that it was unlikely to cut the interest rate on commercial bank reserves. Unless, you expect the UK economy is going into a financial melt-down like that seen in 1992, we can't see a compelling reason for the NZD to continue to outperform GBP in the short-term. We look for NZD/GBP to slide back towards 0.4000-0.4200 in coming months. Today's National Bank Business Outlook should provide some insight on how the gap between extremely bullish business sentiment and still-weak actual activity will be resolved. We wouldn't be surprised to see the headline confidence measure pull back a little. For today, expect bounces in NZD/USD to be limited to 0.7200-0.7220. Initial support is eyed ahead of 0.7110, but a break below this level will open up the downside towards 0.7060. It was a relatively choppy night, but the USD finished the night up against most major currencies. USD sentiment was bolstered by two main factors: (1) comments from the Russian central bank making it clear that it wasn't planning to reduce the proportion of its reserves held in USD; and (2) Fed rhetoric highlighting the possibility of a swift policy reversal. EUR/USD slipped from nearly 1.4650 to below 1.4540 and USD/JPY climbed from sub-86.70 to nearly 90.40. The Russian central bank said Russia will keep the share of its foreign reserves held in US Treasuries steady at about 30%. While the Russian central bank blames much of the financial crisis on an over-reliance on the USD and the US financial system, Deputy Chairman Ulyukayev said liquidity constraints mean that "currency reserves can't, unfortunately, be significantly diversified." Dallas Fed President Fisher said the Fed will need to start removing policy accommodation as soon as the US economy shows convincing signs of traction. Fisher went on to add that the "speed and intensity" of tightening could equal that seen when the Fed was easing. Fisher's suggestion of a swift policy reversal echo those made by the Fed's Warsh late last week. However, last night's US data suggests the US recovery is still fragile. The S&P/CaseShiller house price index showed a modest improvement, rising to -13.3%y/y in July from June's -15.44%. But Conference Board consumer confidence fell to 53.1 in September, well below the 57.0 forecast. European indices fell modestly 0-0.5% and the S&P500 is currently flat. GBP/USD bucked the firmer USD trend, rising from below 1.5830 to above 1.5980. In the seminar organised for UK economists, the Bank of England made it clear it was unhappy with the way the currency market reacted to Governor King's remarks last week (King said the weaker GBP could help a fragile economy rebalance). The BoE also signalled that it was not planning to cut the interest rate on commercial bank reserves. In response, UK 2-year government bond yields jumped 10bps to 0.90%. The USD looks poised to extend its recent recovery. Not only do we think the chatter about central bank diversification away from USD reserves is overblown, but investors have got overly optimistic on the strength and timing of the global recovery. If this week's economic news fails to justify the upbeat global outlook currently priced into markets, look out for a correction in equities and a rebound in the USD. ____________ * Danica Hampton is BNZ's Senior Currency Strategist. All of the research produced by the BNZ Capital team of economists is available here.