Opinion: NZ$ slumps on Euro, China fears; focus on Budget 2010 at 2pm

By Mike Jones The NZD has been the weakest performing currency over the past 24 hours. From around 0.6950 this time yesterday, NZD/USD slumped to 9-month lows below 0.6700 overnight. A one-two punch of lower risk appetite and sliding global commodity prices knocked back the NZD over the past 24 hours. The aftershocks of Germany’s surprise decision to ban ‘naked’ short selling has seen equity markets remain weak, keeping investors risk averse. Equity markets across Asia, Europe and the US have posted heavy declines and our risk appetite index (which has a scale of 0-100%) has plunged to 36%, from 40% at the start of the week. Meantime, commodity prices have dropped away sharply. Not only have European debt concerns increased the risks to the global outlook, but China continues to cut capacity and implement measures to restrain domestic demand. The CRB index (a broad index of commodity prices) fell a further 1% overnight to 8-month lows almost 10% below early May levels. Against this backdrop, model and short-term speculative accounts have taken flight from the NZD, liquidating earlier ‘long’ positions. NZD/JPY dropped from above 64.00 to almost 61.00 and NZD/USD dived nearly 3%, to an overnight low around 0.6660. While tax changes will occupy most of the media attention from this afternoon’s budget, it’ll be the more boring bits that will have the most relevance for the NZD. Overall, we expect the fiscal accounts to look not so bad as before, underpinned by an improving economic outlook. We anticipate smaller deficits, over time, leading to net debt rising at a slower pace and a not-so-high bond programme. Failing another major meltdown in Asian equity markets, we wouldn’t be surprised to see the NZD/USD pare some of its losses today. Still, with risk appetite very much in the doldrums, rallies will most likely be capped to the 0.6850 region in the short-term. Initial support is seen towards last night’s low of 0.6660. Majors Last night’s currency movements were a bit of a mish-mash. The EUR finally managed to find some friends, helping the USD pare some of its recent gains. However, with risk appetite and commodity prices still in the doldrums, “growth-sensitive” currencies underperformed. Investors were comforted to some extent by suggestions other major countries won’t follow Germany and implement bans on ‘naked’ short-selling. Officials from France and the US both suggested as much. Nevertheless, fear and uncertainty is still rife following Germany’s surprise ban yesterday. Following a grim day on Asian stock markets, European equity indices all fell 2.5-3.0% last night and the S&P500 is currently down around 0.5%. Indicative of the souring in risk appetite, the VIX index (a proxy for risk aversion) pressed higher still, rising from 34% to almost 38%. Rising risk aversion and fears about the strength of global demand saw commodity prices and “growth sensitive” currencies extend their losses overnight, despite a small fall in the USD. The CRB index (a broad index of commodity prices) is down around 1% and AUD/USD, CAD/USD and NZD/USD registered declines of 0.8-2.9%. Rumours and hearsay were the main factors propping up EUR last night. First, speculation did the rounds Greece may leave the Eurozone following comments from German Chancellor Merkel that the EU needed an “orderly” process for facilitating default for the region’s "notorious deficit sinners". In addition, a report from a US think tank suggested the G7 is worried about the speed of the EUR decline and is pondering some form of ‘multilateral intervention’ to halt its slide. EUR/USD climbed from 1.2200 to nearly 1.2400. A spike in EUR/CHF from 1.4000 to 1.4275 added support, amid rumours of Swiss National Bank intervention. GBP/USD was dragged above 1.4400 on the coat-tails of the firmer EUR. This was despite last night’s Bank of England minutes reaffirming the need for UK interest rates to remain low for some time. The MPC voted unanimously to keep interest rates unchanged at 0.5%, but said a quicker pace of fiscal consolidation was required. The May FOMC minutes revealed the Fed has upgraded its outlook for US economic growth and has begun discussing strategies for reducing the size of its balance sheet. Still, there is relatively little prospect of policy tightening anytime soon. Fed members appear (rightly) unconcerned about US inflation pressures, sentiments reinforced by last night’s 0.1%m/m fall in the US April CPI (+0.1% expected). *All of the research produced by the BNZ Capital team of economists is available here