Opinion: Kiwi$ starts week softly as US$ strengthens on Middle East, European fears

By Danica Hampton NZD/USD fell steadily last week. After climbing to nearly 0.7300 last Monday, the local currency slipped below 0.7100 on Friday night. The USD pushed higher against most currencies on Friday night. Investors shrugged off upbeat German IFO data and instead fretted about European bank write-downs (the ECB upwardly revised its estimates to €553b) and news that Iranian troops had entered a disputed oilfield in Iraq. Against this backdrop, risk appetite faltered and the NZD/USD skidded briefly below 0.7080. Much of the weakness seen in the NZD/USD last week simply reflects a stronger USD. On a trade-weighted basis, the USD climbed more than 2% last week to a 3-month high of above 78.00. While upbeat US data and worries about the European banking sector have helped the USD, we suspect most of the recent strength reflects the squaring up of "short USD" positions. The CFTC report (for the week ending 15 December) shows that speculative positions in USD have been slashed by 75% since the start of December (where they peaked at around 180,000 contracts). With market positioning now looking more balanced, further gains the USD will likely be hard fought (requiring either upbeat US data or a worsening risk appetite). Last week's speech from RBA Deputy Governor Battelino saw investors pare back RBA tightening expectations and NZ interest rates were dragged lower by association. Indeed, NZ-US 3-year swap spreads narrowed about 13bps to 3.29% last week. However, the fundamental backdrop remains relatively supportive for the NZD. Wednesday's Q3 GDP report will likely confirm the NZ economic expansion is underway, albeit slowly (we're looking for 0.3%q/q). Meantime, Tuesday should reveal another slimming in the current account deficit "“ to about 3.8% of GDP for the year to September. After slipping steadily last week, we're looking for the NZD/USD to consolidate this week. In the absence of a daily close below 0.7080, we suspect dips below 0.7100 will be short-lived. The USD firmed against most of the major currencies on Friday night. Upbeat German IFO data helped EUR/USD flirt with 1.4400 early in the night. Business confidence rose to 94.7 in December (vs. 94.5 forecast) and the expectations index rose to 99.1 (a touch better than the 99.0 forecast). However, the USD strengthened as the night wore on amid news the ECB upwardly revised its estimates of European bank write-downs (to €553b from June's estimate of €488b) and that Iranian troops had entered a disputed oilfield in Iraq. EUR/USD slipped briefly below 1.4280, before rebounding and finishing the week around 1.4350. The USD was the strongest performing currency last week "“ rising more than 2% on a trade-weighted basis. While upbeat news on the US economy and faltering risk appetite (amid worries about the health of the European financial system) helped the USD, we suspect most of the recent strength reflects the squaring up of "short USD" positions in the lead up to the Christmas break. Indeed, the CFTC report (for the week ending 15 December) shows that speculative positions in USD have been slashed by 75% since the start of December (where they peaked at around 180,000 contracts) to around 45,000k contracts. The key question is whether this USD strength simply reflects market positioning or is it sustainable? It's clear the short USD market has been unnerved over recent weeks by the improvement in US data "“ including non-farm payrolls, retail sales, industrial production and some housing data. But last week's Fed affirmation that rates will remain low should have helped calm speculation about near-term Fed tightening. US government bond yields finished the week more or less unchanged (2-year yields around 0.80% and 10-year yields at 3.54%). All in all, there doesn't appear to be a fundamental reason to chase the USD higher from here. With speculative market positioning now looking a bit more balanced, currency markets may settle down a bit this week. However, with concerns about the health of the European banking sector lingering, EUR/USD could push a little lower towards 1.4200 before finding a base. This week's data includes the final estimate of US Q3 GDP (which is expected to remain unchanged at an annualised pace of 2.8%). However, given the Fed's relatively upbeat of the US economy, we suspect there will be more interest in how growth is progressing in Q4. In the UK this week, Q3 UK GDP is expected to be revised up (from -0.3%q/q to -0.1%q/q) and the Bank of England minutes are also due. * Danica Hampton is BNZ's Senior Currency Strategist. All of the research produced by the BNZ Capital team of economists is available here.