Opinion: NZ$ falls heavily overnight; 'Govt can do nothing directly about NZ$', English says

By Danica Hampton NZD/USD fell heavily last night. After flirting with 0.6900 early in the night, the currency is closer to 0.6750 this morning. Fears about the financial sector gripped investors last night. Rumours that a US bank was in trouble saw equity markets plunge and risk aversion sky-rocket. Our risk appetite (where 0% = risk averse and 100% is risk loving) fell to 39% last night "“ its lowest level in about eight weeks. Against this backdrop, investors shunned growth sensitive currencies like NZD in favour of the relative safety of the USD and JPY. New Zealand's Finance Minister Bill English was on the wires last night. English said the current level of the NZD means an export-led recovery will be "something of a challenge", but acknowledged there was nothing the government could directly do about the currency. English's comments echo those made by RBNZ Governor Bollard earlier in the week.

NZD selling was noted from a range of short-term speculative players, model-driven funds and real-money accounts. NZD/JPY fell from above 64.00 to nearly 62.50 and NZD/USD was dragged below 0.6750. A strong result from Fonterra's online dairy price auction provided some fleeting support for NZD/USD. The average price of whole milk powder jumped 24.2% to US$2,858 at last night's auction. This is the second consecutive month of strong gains and the average price of whole milk powder is now up about 55% from the lows seen in July. The recent strength in dairy prices suggests dairy exporters may be somewhat insulated from the effects of the rising NZD and increases the chances of Fonterra being able to meet its NZ$4.55 payout forecast. While Fonterra's online auction was positive news, we suspect worries about the financial sector and risk aversion will dominate currency markets today. As such, we suspect NZD/USD will struggle to break above 0.6800-0.6820. Initial support is seen ahead of 0.6700, but the risks seem skewed in favour of a deeper correction towards 0.6650 if risk appetite and Asian equities remain defensive. The USD strengthened against most major currencies as heavy losses across equities and worries about the global outlook prompted "safe-haven" demand. Financial sector concerns weighed heavily on global equities last night. It's hard to pinpoint the exact catalyst "“ but rumours that US bank Wells Fargo was in trouble did the rounds. Shares of the US insurance giant AIG fell about 17% after a US stockbroker downgraded the struggling insurer. And most banking stocks have chalked up heavy losses - Citibank fell about 12% and both Morgan Stanley and Wells Fargo are down about 4%. Heavy losses in financial stocks led European and US equity markets lower. European indices fell 2-2.5% and the S&P500 is currently down 1.8%. Concern about the financial sector combined with heavy losses across global equities saw risk aversion sky-rocket. The VIX Index (the implied volatility of the S&P500 commonly used as a barometer of risk aversion) spiked to 28.5% - its highest level in seven weeks. Against this backdrop, investors ditched growth sensitive currencies in favour of the relative safety of the USD and JPY. EUR/USD plunged from above 1.4350 to below 1.4200. Real money funds and model accounts continue to be active sellers of EUR. While US data surprised on the upside, this did little to help investor sentiment. The US manufacturing ISM rose to 52.9 in August, well above the 50.5 forecast (but lower than the 55 whisper number that did the rumour circuit earlier in the night). The unexpectedly strong rise in pending home sales (3.2%m/m vs. 1.5%) was consistent with the US housing market stabilising. Last night's European data was mixed. The UK manufacturing PMI slipped to 49.7 in August, well below forecasts for 51.5 (and July's 50.8). While the Eurozone manufacturing PMI surprised on the upside (rising to 48.2 in August from 47.9), it still remains below the 50 threshold that signals expansion. While there is still plenty to keep an eye on data-wise this week, we suspect worries about the financial sector and risk aversion will dominate currency markets near-term. This suggests EUR/USD will likely continue to struggle towards 1.4400-1.4450 and the USD Index will likely find solid support on dips towards 78.00. Any further deterioration in risk appetite should underpin the USD and pave the way for EUR/USD to sink back towards 1.4050-1.4100. * Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Capital team of economists is available here.