Opinion: NZ$ strengthens near 66 USc as risk appetite improves

By Danica Hampton The currency markets have started the week with real money and corporate hedging support, the optimism of last week's equity markets still prevalent in sentiment. Sentiment that has also been generally well served by recent data releases that continue to show some signs of economies stabilising, encouraging the VIX to ease as a sign of improving investor risk appetite. Yesterday's financial rescue of the business operations of CIT was also encouraging for investors on the day. Even the RBNZ Governor in his speech last week, simply titled "Economic Recovery" unwittingly provided some impetus despite his broader cautionary theme when he noted that "New Zealand looks likely to start recovering ahead of the pack". The Governor's concerns were of course acknowledged by Fitch when they pulled back NZ's sovereign rating outlook to negative last week but the growing appetite for risk has seen the Kiwi regain lost ground. Despite the general lift in attitude toward risk, our risk appetite index is now at its highest level since the Lehman's collapse of last September "“ as the NZD/USD looks set to trade into overbought territory. Our short term valuation model (based on risk appetite, NZ-US swap spreads and commodity prices) suggests a fair value range of 0.5924/0.6124 "“ that said the NZD opens this morning having broken above the resistance area of 0.6525/0.6550 with early June high's at the 0.6600 level within sight. Yesterday's PSI showed the service sector continues to contract, but new business levels may provide better results in the months ahead. Our own economists said that June's performance of services showed the first positive index for forward orders in a long while. Today we have June's net migration and the result looks likely to be another strong one, mostly courtesy of New Zealanders choosing to stay put. As for short-term arrivals, we expect they will reflect a surge in visits from Australia but significant weakness from longer-haul tourist markets. Monthly credit card billings have been as volatile as ever of late, but we suspect the trend will continue to look little better than flat when reported at 3:00pm this afternoon. While there are a number of event risks this week, the Bernanke semi-annual monetary policy reports to the House and Senate panels on Tuesday and Wednesday will dominate and will likely prove influential for the USD. The USD's recent losses come as risk appetite recovers amid some improved US economic releases (retail sales and housing) and as equity markets post gains (S&P rose almost 7% last week) aided by increased bank profits. Latest IMM data for the week to Tuesday 14th July shows the largest net USD short position since July 2008 at -92k contracts. This could be a sign that investors are becoming more USD bearish, with data showing short USD's across IMM currencies with the exception of GBP. It may well be that investors are becoming more nervous about potential inflation arising from quantitative easing, fear of debt monetisation or the huge increase in supply. These fears and the significant deterioration in the fiscal situation saw US assets wobble in early June, with equities, bonds and the USD all coming under pressure. We believe the US monetary authorities are well aware of these risks and the fine line they are treading in ensuring foreign capital inflows at the same time that the underlying economic situation is deteriorating. For these reasons we believe Bernanke will attempt to address such concerns this week. He will certainly be asked by members of the respective panels. There is a risk that Bernanke fails to deliver or that he leaves the impression that QE may be extended. The latter in particular would knock the USD again, but at just over half way through the US Treasury buying programme in terms of time and size ($300bn started in March and should continue until Sept), there is no pressing need to be specific this week - especially if investors are displaying renewed nervousness. We expect Bernanke to toe a cautiously optimistic line that underscores the improvement in financial market conditions, the Fed's sanguine view on inflation, while noting the Fed funds rate will remain exceptionally low for an extended period. In the interests of calming investor nerves he will express the desirability of a clear exit strategy for when the time is right as well as returning to fiscal sustainability over the longer-term. * Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Capital team of economists is available here.