Opinion: Testing lows

By BNZ Currency Strategist Danica Hampton The NZD/USD has fallen over the past 24 hours, sliding from above 0.6950 yesterday morning to nearly 0.6800. There's been plenty of news to digest over the past 24 hours. As widely expected, the RBA cut interest rates 25bps to 7.00% yesterday. While the accompanying statement left the door open for further rate cuts with the phrase, "there was now scope for monetary policy to become less restrictive", it didn't suggest the RBA was about to embark on a significant easing cycle. We look for the RBA to cut another 25bps in October to 6.75%, but the central bank is then likely to pause until 2009. Despite yesterday's RBA statement and an article from noted RBA watcher Terry McCrann suggesting the RBA "may not go much further on rate cuts", the AUD was the worst performing currency last night. Overnight, a massive slide in crude oil prices (futures fell more than 5% to US$105.50/barrel) triggered a sharp bout of USD strength early in the offshore session. Heavy AUD selling was also noted from various macro-driven accounts, which combined with steady NZD/JPY supply, pressured NZD/USD to within a whisker of 0.6800 "“ its lowest level since August 2007. NZD/USD edged off its lows as the night progressed. The USD strength started to fade as US stock markets erased earlier gains (thanks to concern about Q3 earnings at Lehmans) and the ISM manufacturing index disappointed expectations a little. For today, the global backdrop of broadly firmer USD should limit bounces in NZD/USD to the 0.6930-40 region. Initial support is seen ahead of 0.6800. Keep an eye out for Australia's Q2 GDP release (1:30pm NZ time), where the market is looking for growth of 0.4%q/q. While signs that Australian growth is holding up okay should support AUD and provide a bit of a prop for NZD/USD, we'd also expect to see renewed downward pressure on NZD/AUD. Majors The USD strengthened against most of the major currencies last night, benefiting from the massive slide in crude oil prices. Crude oil futures fell more than 5% to below US$105.50/barrel early in the offshore session as Hurricane Gustav proved weaker than expected. With little damage to US refineries or rigs, market participants are now convinced that any fall in oil production will likely be temporary. EUR/USD skidded from around 1.4600 to below 1.4470, while USD/JPY climbed steadily from around 108.00 to nearly 109.20. However, the USD strength started to fade as the night progressed as renewed concerns about the financial sector saw US equity markets erase earlier gains. And the ISM manufacturing index disappointed; falling to 49.9 in August vs. 50 forecast. EUR/USD rebounded off its lows and stabilised around 1.4500, while USD/JPY settled around 108.80. At one point, US equity indices were up nearly 2%, but panic around Lehmans (now the Korea Development Bank investment appears to be falling through), news that bond insurer CIFG will terminate US$12b in guarantees and Fitch's decision to cut Fannie Mae and Freddie Mac preferred stock rating to "BBB-" from "A+" took a toll. The S&P500 is currently down 0.75%. While the US economy is far from a picture of health, we can't help but think the USD will continue to come off looking the best of a bad bunch. Minutes from the recent discount rate meeting showed that 3 out of 12 regional Federal Reserve Banks voted to raise the discount rate at the last meeting on August 5. While recent FOMC minutes have made it clear the Fed is in no hurry to raise the Fed Funds rate, the next move will most likely be higher. The ECB is widely expected to keep rates steady at 4.25% on Thursday, but with the Eurozone economy already halfway to a formal recession the ECB's optimism looks increasingly misplaced. Similarly, the Bank of England is likely to hold rates steady at 5.00% this week, but the MPC's inflation concerns will likely be overshadowed by the risk of a UK recession in coming months. In the absence of a serious stock market plunge, a spike in crude oil prices or a disastrous US non-farm payrolls number (due September 5) we expect the USD will remain firm over coming months. -------------- * Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Markets team of economists is available here.