Opinion: NZ$ surges as global sentiment improves

By Danica Hampton The NZD/USD surged to around 0.6865 on Friday night "“ just a smidge under the year-to-date high of 0.6880 reached on August 14. Global sentiment improved on Friday night. Not only did the US data surprise on the upside (existing home sales rose 7.2% in July, well above the 2.1% forecast), but Fed Chairman Bernanke also said the "prospects for a return to growth in the near term appear good" for both the US and the global economy. Equity markets rebounded strongly "“ the S&P500 rose 1.9% on Friday and climbed to a fresh year-to-date high. The Shanghai Index also finished the week strongly - rebounding some 7% from its mid-week lows. Against a backdrop of firmer global equities and revived risk appetite, growth sensitive currencies like NZD pushed higher against "˜safe-haven' currencies like the USD and JPY. Patches of demand from leveraged accounts saw NZD/AUD flirt with 0.8200, which also helped underpin NZD/USD. The prospects for the global economy seem brighter than this time last week. While global equity markets continue to rally, commodity prices continue to firm and risk appetite remains buoyant, we'd expect the NZD/USD to stay supported on dips towards 0.6650-0.6700. The important question near-term is whether or not investors think the global backdrop has improved sufficiently to see NZD/USD break into fresh ranges. There are plenty of risks out there "“ many equity markets are still over-stretched relative to valuations and US interest rates have risen sharply (i.e. NZ-US interest rate spreads have contracted sharply). For NZD/USD, we suspect we'll find some headwinds around the year-to-date high of 0.6880. However, if the global backdrop continues to improve and the USD Index break below its year-to-date low of 77.45, expect NZD/USD to push up towards 0.6900-0.6950. This week's data is unlikely to dislodge the positive NZD sentiment. Thursday's trade deficit will likely widen to NZ$635m, but Friday's building consents and credit card spending are expected to show improvement. The USD weakened against most major currencies on Friday night amid evidence the global economy is on the road to recovery. Early in the week, the trend towards a weaker USD took a bit of a breather as lacklustre US consumer confidence data and heavy losses in Chinese equities saw concerns about the global outlook resurface. These fears served to knock investors' risk appetite, reinforcing "safe haven" demand for the USD. However, these concerns faded on Friday night. US existing home sales increased 7.2% to the highest level in almost two years. Fed chairman Bernanke then added to the positive sentiment while addressing the Fed's annual Jackson Hole conference. Bernanke noted "After contracting sharply over the past year, economic activity appears to be levelling out"¦prospects for a return to growth in the near-term appear good." Not surprisingly, US stocks rallied hard on the news. The S&P500 surged nearly 2% to reach new highs for 2009. Against this backdrop, investor risk appetite received a clear boost, reducing demand for "safe haven" currencies such as JPY and USD. With the USD once again retreating, most of the major currencies ended the week higher. The CAD was one of the strongest performing currencies over the week as improving global sentiment saw oil prices hit 11-month highs. Meanwhile, another batch of stronger-than-expected European PMIs helped push the EUR up to around 1.4330 by the end of the week. Looking ahead, we think downward pressure is likely to remain on the USD in the near-term as evidence that the global economy is recovering continues to mount. Investor risk appetite is still the dominant factor driving currency direction for now, despite murmurings that interest rate differentials may start to have more influence. We note that Friday's 0.5% depreciation in the USD index occurred despite a 13bps increase in US Treasury yields. While markets will no doubt get carried away at times, bouts of risk aversion will remain relatively short-lived in our view. As such, a re-test of the year-to-date lows around 77.50 on the USD index looks likely for this week. US data will be influential this week in dictating market sentiment. Tuesday brings the Case-Shiller house price index and US consumer confidence, while Wednesday's data includes July durable goods and new home sales. Elsewhere, the data calendar is reasonably light, with the German IFO the main release of note. * Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Capital team of economists is available here.