Opinion: Kiwi$ looks overstretched but weak US$ keeps it around 62 USc

By Danica Hampton With both the US and UK markets closed it was a relatively quiet offshore session in currency markets. NZD/USD spent most of the night puddling around in a 0.6150-0.6200 range. News of nuclear testing in North Korea put risk sensitive currencies like NZD and AUD under selling pressure late yesterday afternoon. However, with the Japanese government upgrading their assessment of the economic outlook (it now thinks the "tempo of the worsening has become moderate") the weakness in NZD/USD was short-lived. Steady demand from real-money accounts and Asian retail players saw NZD/USD climb back towards 0.6200. From a fundamental perspective, we continue to think NZD/USD looks over-stretched. The recent increase in the currency has outpaced the increase in risk appetite, NZ commodity prices and the widening of NZ-US 3-year swap spreads. The implied "fair value" range for NZD/USD (according to our short-term valuation model) has increased over the past fortnight, from 0.5550-0.5750 to 0.5680-0.5880, but remains significantly below the current market level. Nor should we forget that the rapid strengthening of the currency, and effective tightening of financial conditions, is a potential threat to a NZ economic recovery. But markets are not always rational and currencies can deviate from economic fundamentals for substantial periods of time. The key to the near-term fortunes of NZD/USD is really USD sentiment. Should investors remain concerned about the burgeoning US fiscal deficit and worried about the US possibly losing its triple-A credit rating, we'd expect generalised USD weakness to continue to keep NZD/USD underpinned. For today, we suspect dips will be limited to the 0.6130-0.6140 region. Initial headwinds are expected ahead of 0.6240, but a break above this level will open up the topside towards 0.6280-0.6300. The USD held steady against the major currencies last night. But it was a relatively lacklustre night in currency markets with both the US and UK markets closed. EUR/USD spent most of the night in a 1.3960-1.4040 range. While the news out of the Eurozone wasn't particularly inspiring, the rebound in German's IFO suggests the pace of the decline in the Europe's largest economy may be easing. The business climate index rose to 84.2 (vs. 85.0 forecast) and the current situation index fell to 82.5 (confounding expectations for a climb to 84.5). ECB council member Weber also warned "it's too early to call the end of the crisis" and cautioned that unemployment was unlikely to peak until late 2010. USD/JPY climbed from below 94.50 to around 95.20 following reports that North Korea had successfully conducted a nuclear test and test-fired three short-range missiles. Sentiment towards the JPY was dented due to Japan's geographical proximity to North Korea. However, the news out of Japan was cautiously upbeat. Japan's government raised its assessment of the economy for the first time in about three years. Government officials said the "worst of the recession may be over in the sense that the economy has stopped worsening sharply", but cautioned that employment prospects would likely deteriorate short-term. Bank of Japan Governor Shirakawa shared this cautious optimism "“ warning that any recovery in the world economy will be mild as it will take considerable time to get rid of the excesses built up during the growth years. It's also worth noting, preliminary data from the OECD shows that GDP (from the 30 OECD countries) fell 2.1% in Q1 "“ the largest drop since 1960 when records began. Despite last night's mish-mash of news, the USD failed to gather too much ground as investors remain concerned about the burgeoning US fiscal deficit and worried about the US's triple-A credit rating. The near-term fortunes of currencies will depend on how USD sentiment unfolds. Specifically, investors will be closely watching how the market absorbs this week's US Treasury bond auctions and whether or not the Fed steps up its purchases of government debt. Should investors remain concerned about how the US government will fund its budget deficit, and longer dated US bond yields continue to rise, we'd expect the USD to remain under selling pressure. ____________ * Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Markets team of economists is available here.