Opinion: Strengthening risk appetites boost Kiwi$...for now

Opinion: Strengthening risk appetites boost Kiwi$...for now
BNZ Currency Strategist Danica HamptonBy BNZ Currency Strategist Danica Hampton The NZD/USD rebounded strongly towards the end of last week, following news that the US Treasury was putting together a comprehensive bail-out package in order to stabilise the troubled US financial sector. News of the US bail-out plan triggered a strong recovery in global equity markets (FTSE rose 8.8%, DAX rose 5.6% and the S&P500 rose 4.0%), which underpinned risk appetite and demand for currencies like NZD/JPY. Our risk appetite index (which has a scale of 0-100% and a long-term average of 50%) rebounded from last week's low of 25% to 33% and NZD/JPY climbed from below 71.00 to above 74.00. Meantime, as more detail about the US Treasury bail-out plan emerged making it clear the plan would be financed out of US government debt and this triggered heavy selling of USD. Against a generally weaker USD, strong demand for NZD/JPY, saw NZD/USD climb from around 0.6750 to above 0.6900. The turmoil in financial markets completely dominated currency markets last week and this week's focus will be on whether or not US Congress passes the US Treasury's proposed bail-out package and what this means for global equity markets, risk appetite and the USD. Last week's recovery in risk appetite and the generally weaker USD will provide some support for the NZD/USD early this week. However, with NZ teetering on the brink of recession (this week's GDP should confirm that growth also contracted in Q2), the RBNZ expected to cut rates aggressively over the coming months (our economists are looking for a trough of 6.00% next year) and global investor confidence still fragile, we expect sellers to emerge on bounces above 0.7000. On the downside, solid support is seen below 0.6600 and it will take a break below 0.6440 (the low of September 11) to suggest the downtrend is gaining traction. Friday night was all about the US Government's assault on the financial crisis, which includes a ban on short-selling of financial stocks and a comprehensive bail-out plan for US banks. Key points of the US Treasury's bail-out package:
  • The US Treasury will have authority to issue up to US$700b of debt to finance the purchase of troubled assets. While these assets are intended to be residential and commercial mortgage related assets, other assets may also be bought if deemed necessary to stabilise markets.
  • To qualify, the assets must have been originated or issued on or before 17 September 2008 and participating financial institutions must have significant operations in the US.
  • The assets will be managed by private asset managers at the direction of Treasury. The assets may be sold or held to maturity at the Treasury's discretion. Cash received will be returned to Treasury's general fund for the benefit of US taxpayers.
Financial stocks rebounded strongly in reaction to bail-out news and this lifted equity markets around the globe. The S&P500 climbed 4%, the FTSE surged 8.8% and the DAX rebounded 5.6%. Meanwhile, the unwinding "safe-haven" flows saw US interest rates climb markedly. US 2-year government bond yields climbed 47bps to 2.16% (back to where yields started the week). Despite the rebound in US equities and US interest rates, the USD weakened against all the major currencies. While the bail-out package helped lift investor confidence, currency traders worried about how the bail-out package will be financed. The rapid expansion of US government debt and the fiscal deficit are both negatives for the USD as they risk spurring inflation and eroding real US interest rates. EUR/USD surged from around 1.4150 to nearly 1.4500, while USD/JPY slipped from above 108.00 to below 107.00. The turbulence in financial markets (the bankruptcy of Lehmans, the bail-out of AIG and several forced investment bank mergers) followed by the malfunction of global credit and money markets completely dominated currency markets last week. The focus this week will be on whether or not Congress passes the US Treasury's proposed bail-out package and ultimately what this means for the USD. The knee-jerk reaction will be to sell USD, as investors worry about the twin US deficits and what this may mean for real US interest rates. However, given the unprecedented moves in the banking sector and the speed at which the whole financial marketplace is being redrawn, it is difficult to hold a view on currencies with any real degree of conviction. A starting point in such circumstances would be to draw a straight line down the middle of the page and note the USD positives in one column and the negatives in the other. USD positives include the repatriation of overseas held investments back to the US, the USD's long-standing reserve currency status, the clear determination of the US authorities to head off a downward spiral of asset market declines and the refusal of the Fed to give in to calls for a further reduction in official interest rates. The negatives are the potentially unlimited increase in US money supply and the unknown obligations of the banking system which are to be absorbed by the US taxpayer. It's too early to conclude which of these will be the dominant influence on sentiment and activity. But, for now, we'll stand by our previously held view for further USD strength, but caution that these are rapidly changing times and packed full of uncertainty. * Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Markets team of economists is available here.

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