Opinion: Kiwi$ falls overnight, may fall further if US$ extends gains

By Danica Hampton NZD/USD has skidded lower over the past 24 hours. After starting the week above 0.6400, the local currency is now sitting closer to 0.6300. Currency markets started the week with a stronger USD theme. Comments from the Russian Finance Minister helped support the USD, as they suggest this week's BRIC summit won't focus on trying to replace the USD as the predominant global reserve currency. Meantime, the ECB's Financial Stability Review spooked investors with its estimate of total European bank write-downs (estimated at US$649b vs. US$366 already announced) and Eurozone employment fell 1.2%y/y in Q1. As a result, EUR/USD slipped from around 1.4000 to nearly 1.3750. Questions over the speed and timing of the global recovery saw global equities slip sharply last night. European indices fell 2.5-3.5% and the S&P500 is currently down 2.5%. This encouraged investors to sell growth sensitive currencies like NZD, particularly against the USD and JPY. Macro-driven funds and custodial accounts have been steady NZD sellers over the past 24 hours. Looking ahead, there is plenty to watch for today. The RBA minutes (due 1:30pm NZ time) may shed further light on what would justify further Australian rate cuts (after the June statement said "scope remains for some further easing of monetary policy, if needed"). The Bank of Japan monetary policy announcement is also due later today. While the cash rate will likely remain unchanged at 0.1%, the BoJ is expected to upgrade their assessment of the Japanese economic outlook. For today, the 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 extends its recent gains. The USD climbed against most currencies last night, as investors fretted over large European write-downs, global equities fell and the US yield curve flattened. EUR/USD slipped from above 1.4000 to nearly 1.3750 last night amid concern about persistent weakness in the Eurozone. The ECB spooked investors with its estimates of credit crisis related write-downs. In it's Financial Stability Review, the ECB estimated that bank write-downs related to toxic assets and bad loans would total of US$649b (well in excess of the US$366b that have already been announced). Meantime, the 1.2%y/y drop in Eurozone employment did little to help EUR sentiment. US equities slipped sharply last night, as investors questioned the speed and timing of the economic recovery. Heavy loses in industrial companies and producers of basic commodities led the market lower as a weaker than expected Empire manufacturing data (it fell to -9.41 in June vs. -4.6 forecast) cast doubts over whether the US recession has troughed. European indices fell 2.5-3.5% and the S&P500 fell 2.5%. Comments from various G8 officials also proved supportive for the USD. Russia's Finance Minister said the USD's role as a reserve currency was unlikely to change in the near future. While the IMF's second in command, Lipsky, said "the dollar is the principal reserve currency in the global economy and will remain so for as far as we can see". The comments helped alleviate fears that emerging market countries (like China and Russia) are diversifying foreign reserves away from USD denominated assets. Worries the ballooning fiscal deficit will sour offshore investor demand for longer dated US government bonds saw 10-year yields rise to an 8-month high of 4.00% last week. However, the recent string of official comments, combined with solid demand at last week's 30-year bond auction, has helped assuage these fears somewhat. Last night, the 10-year government bond yield fell 8bps to 3.70% and the flattening of the yield curve (10-2 yield spread fell 5bps to 2.48%) helped support the USD. After weakening steadily since mid-April, the USD has found a bit of reprieve. While we expect the USD to break lower eventually, the recovery probably has further to run near-term. Indeed, the USD is unlikely to break lower until the US yield curve starts to steepen again. In the near-term, we expect bounces in EUR/USD to be limited to 1.3850-1.3900 and we look for a test of support in the 1.3700-1.3725 region in the coming sessions. ____________ * Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Capital team of economists is available here.