By Danica Hampton The NZD/USD skidded lower last night, falling from around 0.6280 to nearly 0.6150 (and trading around 0.6200 at 9 am). Ratings agency Standard & Poor's downgraded Ireland's sovereign credit rating from AA+ to AA (and maintained its negative outlook). The news saw EUR/USD collapse and this led currencies like NZD and AUD lower. Comments from the IMF chief Kahn saying there were still a "lot of bank losses that haven't been disclosed" and rumours suggesting German Bank West LB was in trouble simply added to the firmer USD tone. More generally, the USD continues to benefit from the continued sell-off in short-dated US bond yields (as investors anticipate the Fed tightening rates before the end of the year). US 2-year bond yields have risen more than 40bps to 1.42% over the past week. Indeed, the upward pressure on US interest rates has outpaced that seen in NZ. NZ-US 3-year swap spreads have fallen 40bps to 1.77% over the past week and this has reduced the yield appeal of NZD/USD. Locally, the main focus this week is Thursday's RBNZ decision and some short-term speculative players and macro-driven funds are lightening their NZD exposures ahead of this meeting. Most economists think the actual decision (whether the central bank cuts 25bps or not) is a line call. Even if the RBNZ pauses this week, we doubt the central bank will signal that this is the end of the easing cycle. Furthermore, we expect the RBNZ to reiterate its expectation of no OCR hikes for at least the next twelve months. While not a big headline grabber, keep an eye out for Q1's construction figures (10:45am). We are looking for another clunker where construction volumes fall 8% q/q.
For today, we expect sellers will emerge on bounces towards the 0.6240 region. On the downside, we expect dips to be limited to 0.6125-0.6130. The USD firmed against the major currencies last night as investors digested Ireland's sovereign downgrade and a further sell-off in short-dated US bond yields. EUR/USD collapsed from around 1.4000 to nearly 1.3800 after ratings agency Standard & Poor's cut Ireland's sovereign credit rating from AA+to AA and left the country on negative credit watch. Comments from the IMF chief Kahn saying there were still a "lot of bank losses that haven't been disclosed" and rumours suggesting German Bank West LB flirted with bankruptcy over the weekend also took a toll on EUR sentiment. Across the Atlantic, short-dated US bond yields continue to rise (and the yield curve continued to flatten) and provided a bit of support for the USD. Over the past few days, investors have become increasingly convinced the FOMC will start removing monetary stimulus in coming months. This view was reinforced by Friday night's comments from Atlanta Fed President Lockhart, who said the Fed needs to be "anticipatory" and not wait too long to tighten monetary policy. Money markets are consistent with the Fed raising the cash rate 25bps to 0.50% by December. US 2-year government bond yields rose 9bps to 1.38% last night (and are now more than 40bps higher than this time last week). GBP/USD bucked the stronger USD theme, climbing from around 1.5800 to nearly 1.6100, despite the political mauling that UK Prime Minister Brown is currently receiving. GBP was helped along by a rebound in the Lloyds TSB business confidence survey. From a big picture perspective, we expect the USD to remain heavy over the coming quarters. However, in the near-term, the USD recovery may have further to run and it will be important to watch the US yields for a guide to how far the USD recovery can extend. First, the USD tends to strengthen when the US yield curve flattens. If the 10-2 US yield spread curve continues to flatten (i.e. 2-year bond yields rise at a faster pace than 10-year yields) this should support the USD. Second, the recent sell-off in US 2-year yields has far out paced the upward pressure on short dated yields seen in the UK, Europe or Japan. The widening of the spread between US yields and those elsewhere in the world should add to the yield appeal of the USD. ____________ * Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Capital team of economists is available here.