Opinion: Inflation fears fire up commodity prices
23rd Sep 08, 9:33am
By BNZ Currency Strategist Danica Hampton NZD NZD/USD extended its gains last night, pressured by a generally weaker USD and a surge in commodity prices. Ongoing concern about how the US Treasury's bailout package will be financed continues to take a toll on the USD. Meanwhile, worries the bailout package will spur global inflation has seen investors rush to commodities, which tend to act as a store of value. Crude oil prices surged 24% to US$130/barrel, gold prices climbed 3.5% to US$906/oz and the CRB index is up 3.85%. Against this backdrop, EUR/USD surged from below 1.4500 to above 1.4850 and NZD/USD was dragged up through offers in the 0.6900 region and pushed on to nearly 0.6950. However, heavy losses in US equities helped temper the gains in NZD/USD. The S&P500 is currently down 3.8%, pressured by heavy selling of regional banking stocks (amid speculation the US Treasury bailout package may not benefit the smaller US banks). The slide in US equities and rising risk aversion encouraged some selling of growth sensitive currencies like NZD against "˜safe-haven' currencies like JPY. NZD/JPY slipped from above 74.00 to below 73.00 and this helped knock NZD/USD off its highs. While a generally weaker USD will provide some support for the NZD/USD, we find it difficult to get overly bullish towards the NZD/USD. After all, the NZ economy is slowing sharply and this week's Q2 GDP release will likely confirm that NZ is in fact in recession. Meantime, NZ interest rates are headed lower. We look for the RBNZ to cut 50bps in October, but more importantly we expect the RBNZ will continue to cut rates over coming months. At this stage, our forecasts have the OCR troughing at 6.00% in 2009. It's worth noting, the NZD/USD "fair value" range (as determined by our short-term valuation model) has fallen nearly 2.5% over the past week to 0.6650-0.6850 from 0.6820-0.7020. The drop in "fair value" has been largely driven by a marked narrowing of NZ-US 3-year swap spreads (which have narrowed 40bps to 3.22% over the past week) following the sharp rebound in US interest rates after the US Treasury bail-out plan was announced. However, a drop in risk appetite and continued moderation in NZ commodity prices have also played a part. Overall, while general USD weakness may underpin NZD/USD, we expect sellers to emerge on bounces towards 0.7000-0.7025. On the downside, initial support is seen around 0.6820 and solid support is expected around the 0.6700 region. Majors The USD weakened against all the major currencies last night, weighed down by last night's surge in crude oil prices and ongoing concern about the US Treasury's bailout package. Crude oil prices (as measured by the first Nymex futures contract) surged 24% last night, from around US$104 to US$130/barrel. Crude oil was bolstered by fears the US Treasury's bailout package would spur on global inflation and by data revealing an 11.5% increase in Chinese oil imports in August (a strong recovery from a sharp fall in July). Worries that the massive increase in crude oil prices will handbrake US consumer spending took a toll on the USD. Meantime, ongoing concern about how the Treasury's bailout package will be financed also weighed on the USD. Specifically, the rapid expansion of US government debt and the fiscal deficit are seen as negatives for the USD as they risk spurring inflation and eroding real US interest rates. Against a generally weaker USD and surging crude oil prices, EUR/USD stormed up from below 1.4500 to above 1.4850 and GBP/USD climbed from below 1.8300 to nearly 1.8650. Global equities also slipped last night. The S&P500 fell more than 3.8%, pressured by heavy losses in regional banking stocks. The S&P500 financial index slipped 8.3% and regional banking stocks (including Sovereign Bancorp, Marshall & Ilsley Corp and Washington Mutual) fell more than 20% amid speculation the bail-out package won't have immediate benefit for the smaller US banks and they may have to lower the value of the mortgages they hold based on the prices received by their larger rivals. * Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Markets team of economists is available here.