Opinion: NZ$ fluctuates as markets focus on future of US$

By Danica Hampton The past 24 hours have been relatively choppy for the NZD/USD. Just after 8am it had fallen back below 0.6300 USc after nearly reaching 0.6400 overnight. Comments from the Russian Finance Minister (who said the USD's reserve currency role will be discussed the BRIC [Brazil, Russia, India and China] summit) saw the USD fall sharply. Stronger than expected German ZEW data and UK CPI helped lift EUR and GBP, which added to the heavy USD tone. A generally weaker USD helped underpin NZD/USD. Some commentaries also mention that Asian sovereign accounts showed an appetite for both NZD and AUD overnight. Before long, yesterday afternoon's sub-0.6250 low was a distant memory and NZD/USD climbed to within a whisker of 0.6400. However, the NZD/USD strength proved to be short-lived. The USD recovered a little after the joint communiqué from the BRIC summit didn't bag the USD (it only contained subtle hints that there should be less dependence on the USD). Weakness in US equities (amid ongoing concern about the speed and timing of the global recovery) and a pick up in risk aversion (the VIX index is currently sitting at 33% well above last week's low of 27%) also helped take the shine of growth sensitive currencies like NZD. European equities were more or less flat, but the S&P500 is currently down 1.3%. We doubt the USD weakness will persist today. Not only do we think all the concerns about reserve diversification away from the USD are a bit over-blown, but the US equities remain weak and the US yield curve has continued to flatten. For today, a backdrop of a firmer USD and weak global equities should ensure bounces in NZD/USD are limited to the 0.6350 region. Initial support is seen ahead of 0.6250, but a deeper correction towards 0.6125-0.6150 is possible in coming sessions if the USD continues to strength or risk aversion starts to resurface. The USD slipped against most major currencies last night, following comments from Russia's Finance Minister and upbeat European data. The USD found fresh selling pressure after the Russian Finance Minister warned the BRIC summit would discuss the USD's reserve currency role. However, the joint communiqué of Brazil, Russia, India and China (BRIC) steered clear of any direct assault on the USD. But the BRIC leaders did call for a "stable, predictable and more diversified monetary system". Against a generally weaker USD, EUR/USD climbed from yesterday's low of around 1.3750 to above 1.3900. A stronger than expected German ZEW survey also helped lift EUR sentiment. The headline business sentiment index rose to 44.8 in June, well above forecasts of 35.0. The current situation index rose improved rising to -89.7 (above forecasts of -92.6). Meantime, GBP/USD surged from below 1.6300 to above 1.6500 (a 7-month high on a trade weighted basis) following firmer than expected UK inflation data. Annual UK CPI eased to 2.2% in May (down from April's 2.3%), but economists had been looking for a sharper decline to 2.0%. The latest CPI reading suggests the risk of UK deflation is quite low and follows a slew of data suggesting the UK economy is on the road to recovery. Much has been said of the USD's status as a reserve currency over the past few days. There are subtle hints from the BRIC leaders suggesting there should be less dependence on the USD, while other officials from Japan and the IMF have reaffirmed there's unlikely to be a change to the USD's reserve status any time soon. The key to this argument is timing. Central banks and sovereign wealth funds have been diversifying out to the USD to the benefit of EUR, GBP and commodity currencies over the past 5-10 years and this will likely continue. However, the process of diversification is very slow and gradual. Over the next 10-20 years, the USD will likely have less importance in foreign reserve portfolios "“ but it's not going to happen any time soon. Nor should we overstate the importance of official reserves. In 2008, it was estimated that central banks and sovereign wealth funds held assets worth about US$7-7.5t. However, the size of the assets managed by the private sector is considerably larger. At the start of 2008, data from the Fed showed that private sector funds under management in the US totalled more than US$25t. This suggests that trends in private sector sentiment will actually have a larger impact on currencies. ____________ * Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Capital team of economists is available here.