Opinion: NZ$ hits record high vs pound as European weakness dominates

By Mike Jones It was a bit of a rollercoaster ride in the NZD last week. While firming expectations of a June OCR hike saw NZD/USD well supported early in the week, a slump in risk appetite saw the currency tumble to 0.7150 by Friday. Last week’s NZ Q1 employment report was exceptionally strong, no buts. Employment grew 1.0% in the quarter, and the unemployment rate fell to 6%, blowing market forecasts of 7.3% right out of the water. This, combined with RBNZ Governor Bollard’s comments that monetary stimulus can now be “removed”, saw markets become convinced that the OCR will be raised in June (this has been our view for some time). NZ-US 3-year swap spreads widened accordingly (to 335bps from 310bp at the start of the week), pitching NZD/USD to nearly 0.7300 and NZD/AUD above 0.8050 for the first time since January. However, the positive NZD sentiment evaporated later in the week as financial markets went into panic mode. Fears the rot from Greece’s fiscal crisis could evolve into the global credit crisis mark II sent markets into freefall. Equity markets plunged and risk appetite dried up. Not even Friday’s surging US employment figures (290,000 vs. 190,000 expected) could sway markets’ negative mood. The MSCI World Equity Index finished last week down 8.2% ¬– the largest weekly decline since October 2008. Our risk appetite index (which has a scale of 0-100%) almost halved over the week, to 33.5%. Soaring risk aversion prompted a stampede back into “safe-haven” currencies like the USD and the JPY, at the expense of “growth-sensitive” currencies like the NZD. NZD/JPY slipped to around 65.00 and NZD/USD skidded to 0.7150. Still, it’s worth noting that the NZD held up better than most last week. Indeed, on a trade-weighted basis, the currency hardly moved. Not only did NZD/EUR jump to 2½ year highs above 0.5700, but NZD/GBP rose to fresh 30-year highs above 0.4900, as the UK election failed to produce a clear winner. Despite the global turbulence, local ‘fundamentals’ remain generally supportive of the currency and macro and real money accounts remain keen buyers on dips. For this week, expect the NZD to continue to take direction from offshore. Gyrations in equity market sentiment and risk appetite will be key in this regard, as investors weigh up the contagion effects from the European sovereign debt crisis. All up, with investors risk averse and uncertainty elevated we’d expect rallies in NZD/USD to be limited to the 0.7300 region in the short-term. However, keep an eye out for an announcement from the EU of a new “stabilisation” package for the Eurozone. Whether or not this package is seen to do enough to support Greece et. al will be critical for sentiment early in the week. Majors The “safe-haven” currencies of the USD and the JPY were the strongest performing currencies last week. However, on Friday night, the USD and JPY pared some of their gains, driven by a tentative recovery in the EUR. The 290,000 jobs gain in Friday’s April US non-farm payrolls report was far better than anyone imagined (market expectations were for a 190,000 gain). Still, the report was largely ignored, indicative of markets’ dour mood at present. All eyes were firmly on Europe. Contagion fears from Greece’s fiscal crisis continued to ripple through most asset markets on Friday, following the panicked price action on Thursday. Global stocks posted another day of declines, and risk appetite remained in the doldrums. The S&P500 finished the week down 6.4%, the DAX down 6.9%, while the MSCI World Equity Index fell 8.2% over the week. Meanwhile, the VIX index (a proxy for investors ‘fear’ or risk aversion) rose to 42.3% – the highest since April 2009, having started the week around 22%. Nevertheless, having tumbled to 14-month lows on Thursday, EUR/USD managed to pick itself off the floor on Friday. Not only did the German parliament approve Greece’s aid package, but market chatter suggested the ECB was putting together a credit facility to shore up liquidity worries for European banks. Portuguese and Spanish CDS narrowed slightly and EUR/USD recovered to nearly 1.2750, paving the way for a modest recovery in the most of the majors. USD/JPY rose from 90.50 to around 91.50 – helped by the upbeat non-farm payrolls report – while AUD and CAD lifted 0.3-0.8% off their Thursday lows. In contrast, GBP/USD hit a 13-month low below 1.4500 on Friday as the UK election delivered the first hung parliament since 1974. Investors are worried that the associated political uncertainty will delay action to tame the UK’s budget deficit. However, hopes the Conservative party would try and form a minority government saw GBP/USD recover to nearly 1.4800 late on Friday. Over the weekend, European leaders have been busily putting together a "stabilisation fund" at a special EU summit to try and shore up confidence in the Eurozone. An announcement regarding the details of the package is expected shortly. Market chatter suggests it will involve a new system of government-backed loan guarantees, as well as some form of liquidity support from the ECB, possibly including a quantitative easing programme similar to that adopted by the US and the UK. Markets’ assessment of the effectiveness of the package will be critical to the fortunes of the EUR, equity markets and risk appetite early in the week. *All of the research produced by the BNZ Capital team of economists is available here