By Danica Hampton The major mission in yesterday's Budget was to convince the rating agencies that NZ deserves to maintain its current world standing. It managed to do this by containing expenditure and forecasting NZ's net debt position to stay around 40% of GDP (well below the 70% that seems to have become the norm in the US, UK and Europe). However, Treasury forecasts for the NZ economy were relatively gloomy. Despite implicitly assuming a 2.00% OCR and that the NZD/USD falls to around 0.5000, Treasury have GDP dropping to 1.7% for the March year 2010 (BNZ -1.0%) and a tepid recovery of just 1.8% the following year (BNZ = 3.0%). The ratings agencies were encouraged by the Budget. Standard & Poor's upwardly revised the outlook on the ratings for NZ to "stable" from "negative" and reaffirmed its credit rating at "˜AA+/A-1+'. Despite Treasury's gloomy growth forecasts, the upward revision to NZ's credit rating outlook saw NZD/USD bounce from around 0.6120 to nearly 0.6200.
Overnight, a rebound in US equities and broad based USD weakness saw NZD/USD extend its gains. Another relatively successful US Treasury auction and rumours the Fed has stepped up its purchase of mortgage-backed securities eased fears the recent sell-off in US bond yields would thwart and economic recovery (through higher mortgage and business lending rates). As a result, US equities chalked up modest gains and investors trimmed back "˜safe-haven' positions in the USD. For today, the backdrop of a generally weaker USD should keep NZD/USD underpinned. However, provided the USD Index fails to make fresh lows, we suspect NZD/USD will struggle to break above 0.6280-0.6300. Initial support is seen in the 0.6130-0.6140 region; a daily close below 0.6125 is needed to foreshadow a deeper correction is on the cards. The USD slipped against most of the major currencies last night as a rebound in US equities reduced "˜safe-haven' demand. US equity markets reacted negatively to the sharp sell-off in US bond yields yesterday as investors feared higher mortgage and business lending rates would thwart an economic recovery. Overnight, another relatively successful US Treasury auction (bid-to-cover ratio of 2.26 and indirect bids of 33%) and rumours suggesting the Fed had stepped up its purchase of mortgage-backed securities helped allay some of these fears. As a result, US equities chalked up modest gains and investors trimmed back "˜safe-haven' positions in the USD. Last night's US economic news was a bit mixed. Durable goods orders rose 1.9%m/m in April, well above 0.5% forecast. However, new homes sales rose just 0.3% in April (vs. 1.1% forecast) and mortgage delinquencies rose to a record 9.12% in the first quarter. EUR/USD climbed from around 1.3800 to above 1.3950 last night, underpinned by generalised USD weakness and seemingly upbeat German unemployment data. Unemployment grew by just 1,000 in May, well below the 64,000 forecast. However, a deeper look into the detail suggests unemployment was suppressed by new labour laws, which exclude people on job training schemes being counted. Data from the Bundesbank on short-term workers paints an uglier and probably more accurate picture of the German labour market. Looking ahead, USD sentiment will hold the key to the near-term fortunes in currency markets. However, we're not convinced further dramatic USD weakness is necessarily imminent. This week's US Treasury bond auctions (US$40b 2-year, US$35b 5-year and US$26b 7-year notes) have been fairly well received by investors. Not only were the bid-to-cover ratios relatively high, but there was also a large proportion of indirect bids (which tends to represent offshore demand). This suggests the recent fears about souring offshore demand for USD denominated assets are probably over blown. In fact, the recent sell-off in US bond yields will probably make USD denominated assets more attractive to offshore investors. US-JP 10-year bond spreads widened to 2.26% - the widest since November 2008. US-EU 10-year yields widened to 10bps, in positive territory for the first time in about six months. Nor should we forget a sharp rise in long-dated bond yields is a potential threat to the anticipated global recovery. A sharp rise in wholesale interest rates will likely portend higher mortgage-borrowing rates and impede any recovery in housing activity. For the business sector, the higher cost of capital is a potential threat to business investment and equity prices. Renewed fears about the global outlook or faltering equity markets will likely underpin the USD at the expense of growth sensitive currencies like NZD. ____________ * Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Markets team of economists is available here.