Global risk appetite trends to remain the bigger dollar driver

Global risk appetite trends to remain the bigger dollar driver

By Mike Jones

Considering the magnitude of the disaster, news of Saturday morning's monster Christchurch earthquake had only a relatively minor effect on the currency. In fact, the NZD/USD closed last week just a smidge below 3½ week highs of 0.7220.

However, with the full impact of the quake since having dawned on markets, the NZD/USD has opened this morning 20 points lower around 0.7180. USD weakness was the main theme in currency markets last week.

In fact, the USD index slid nearly 1.5% over the latter stages of the week, providing a default boost to most of the major currencies. Demand for “safe-haven” currencies like the USD and JPY was sapped by a string of upbeat economic data, which tended to allay fears of a sharp slowing in the global economy.

The August Chinese PMI suggested Chinese manufacturing activity remains firm, Australian GDP rocketed ahead 1.2%q/q, and the heavy hitting US ISM manufacturing and non-farm payrolls releases both easily outstripped analysts’ gloomy expectations. Risk appetite was bolstered accordingly. The S&P500 finished the week 3.7% stronger and our risk appetite index (which has a scale of 0-100%) jumped 5 percentage points to 59.4% – the highest since May.

Against a broadly weaker USD, the NZD/USD climbed from around 0.7000 to a three week high above 0.7200. Looking ahead, partial indicators for Q2 GDP dominate the NZ data flow in the week ahead. However, most of local economists’ attention will undoubtedly be on the economic impact of the Christchurch earthquake. From an economic stand point, the disaster is clearly a short-term negative. A significant part of Christchurch city, including the entire central business district, is still barely functional and won't be for some time.

However, as the cleanup gets underway, some economic support can be expected from increased construction activity, consumer spending and downstream support services. We suspect this will place additional pressure on productive capacity and inflation pressures in due course.

As a result, the current NZD/USD sell off as a result of the quake should be relatively short lived. In any case, trends in global risk appetite will remain the bigger driver of the currency in the short-term. While the final clean-up cost of the quake will not be known for some time, current estimates suggest a final bill of around NZ$2b. Part of this will be met via the Earthquake Commission’s (EQC) NZ$5.6b Natural Diaster Fund. According to the EC's 2008/09 annual report, around two thirds of this fund is held in NZ government bonds and inflation indexed bonds. So market participants will be keeping a close eye on these markets to see if there are any implications from EQC activity.

Majors

The USD weakened against most of the major currencies on Friday night as risk appetite was bolstered by August’s encouraging US non-farm payrolls report. US non-farm payrolls fell for a third straight month in August, but the 54,000 reported jobs lost was far less than the 100,000 analysts had expected. What’s more, private employment (which provides a ‘cleaner’ read on the underlying health of the labour market) increased 67,000. The unemployment rate ticked up to 9.6%, as expected.

Revelations that the US labour market is not in as dire shape as earlier feared provided a clear boost to equity market sentiment, bond yields, and risk appetite more generally. Still, a disappointing August read on the US ISM non-manufacturing index (51.5 vs. 53.2 expected) dampened the more optimistic mood somewhat. The S&P500 jumped 1.3%, to finish the week 3.7% stronger. 10-year US Treasury yields ended the night up around 7bps at 2.70% and the VIX index (a proxy for risk aversion) slipped from above 23% to 4 month lows below 21.5%.

Fading risk aversion and generally buoyant sentiment encouraged investors to trim “safe-haven” positions in currencies like USD, JPY and CHF in favour of “growth-sensitive” currencies like AUD, NZD and CAD. Adding to the USD’s woes, PBOC vice-Governor Xiaolian reiterated China’s discomfort in holding most of its reserves in USDs: "Once a reserve currency's value becomes unstable, there will be quite large depreciation risks for assets."

Gains in the EUR were helped along by Friday’s stronger than expected July retail sales and PMI services figures. Meanwhile, GBP/USD tended to underperform after the UK services PMI for August added to the recent string of generally disappointing UK economic news (51.3 vs. 52.9 expected). Despite Friday’s more optimistic global sentiment, most of the major currencies failed to break out of their recent ranges, suggesting investors remain cautious on the sustainability of the global economic recovery.

We suspect this week’s notably light data flow won’t provide any firm answers on this front. Central banks will be in the spotlight with the RBA, Bank of England and the Bank of Canada all due to meet. Only the BoC is expected to shift rates (a 25bps rate hike is expected).

In contrast, speculation about a possible extension to the BoE’s quantitative easing program may well do the rounds ahead of the Thursday’s meeting. Keep an eye on the Australian political situation as well. The weekend’s press suggest a new government could be announced very soon.

* Mike Jones is part of the BNZ research team. 

All its research is available here.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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Amonymous, Winnie is not a trader he is in the Real Services Economy, he has to meet deadlines and payments it is not advisable that he gambles with the insurance money.

Oh I see he is working with the Australian Insurers, then it is up to them. But Anonoymous watching the Chilean exparience just a few months ago , strange as it seems,  these Act of God type of events tend to have very little impact on the Exchange. So I am not betting the farm on any significant moves in the NZD. I am more concerned about the data coming out in the next few days. Would you agree ?

Very simple Winnie, you always operate in the currency you quote and make your payments... NZD

Doesn't that mean they have to pay out in NZD, which means selling USD (say), and buying NZD, thus driving up the NZD value?

Alan.

Okay - so all other things being equal, they borrow those NZD from someone else, and *they* buy them overseas.

However, you look at it, the net end result is an increase in demand for NZD somewhere eventually even if it is in the future.

That still means a net impact to push the NZD higher than it otherwise would have been.

Alan.

Okay - Your sure your right ;-)

Alan.

The large re insurers will be keeping the bulk of their funds safe in USD's, as is the rest of the world. Whether it is actually safe is another debate.

But they will be buying NZD's to cover the losses. The Earthquake commission keeps the bulk of their funds in USDs as well, so they will need to buy NZDs also.

Not only that, apart from the damage to personal property there is liitle evidence that New Zealand's actual productive capacity has been damaged. Take a look at the Japanese earthquakes or even Sept 11. GDP was barely affected as in both disasters the productive capacity in each country was unharmed overall.

There is little reason to sell NZD just on the earthquake, and the buyers will be lining up in the weeks ahead. Offshore events will continue to dominate.

 I'd say if you are going to bank on this mess buy Construction Co shares,  you can't go wrong there and as to currency I would bet on the NZD short term.