By Mike Jones*
It’s been a relatively subdued start to the week in currency markets.
The NZD/USD has spent most of the past 24 hours consolidating in a tight 0.7510-0.7570 range.
Holidays in US and Japanese markets ensured lacklustre trading prevailed overnight. A bout of USD position squaring was the main theme of the night. Profit taking on investors’ large net short USD position knocked most of the major currencies modestly lower, the NZD/USD included.
Contributing to the USD’s bounce, China tightened reserve requirements for the first time since May, triggering a brief bout of investor nervousness and boosting “safe-haven” demand for the USD.
In addition, ECB member Quaden betrayed increased ECB discomfort with the soaring EUR, saying “brutal” movements in foreign exchange need to be avoided. After starting the week around 1.4000, EUR/USD dribbled off to around 1.3890.
Looking ahead, economic ‘fundamentals’ would appear to argue against further substantial NZD/USD appreciation in the near-term. Indeed, the last time the NZD/USD was above 0.7450, NZ-US 3-year swap spreads were around 340bps; this time spreads are closer to 320bps.
The NZD/USD is also trading above the 0.7300-0.7500 “fair-value” range implied by our short-term valuation model. All of this raises the risk of a near-term pullback. However, we suspect positive momentum and buoyant risk appetite will limit any NZD/USD dips to around 0.7300-0.7350 in the short-term. It’s worth noting, our risk appetite index (which has a scale of 0-100%) rose to 62% last week, the highest since May. This week’s mostly second tier offering of NZ economic data means the focus for the NZD will remain offshore.
Thursday’s retail sales and REINZ housing data will likely attract the most attention. For today, initial support is eyed on dips towards 0.7460, while 0.7630 should again cap the topside. Keep an eye out for NAB Australian business confidence, due at 1:30pm.
Currency markets struggled for direction overnight. With an empty data calendar and US and Japanese markets closed for holidays, most of the major currencies simply shuffled around inside their recent ranges. The USD stabilised as traders took advantage of quiet trading to take profit on short positions. The USD index edged up 0.5%. The latest CFTC data shows USD positioning amongst the speculative community reached “extreme” levels last week.
Net shorts rose 8% to US$31b, such that speculators now hold the largest short USD position since November 2007. The firmer USD trend was reinforced by a couple of factors.
First, China announced it was temporarily raising reserve requirements for 6 large commercial banks, by 50bps to 17.5%. This was the first such move since May. In contrast to previous episodes of Chinese policy tightening, market reaction was relatively subdued.
Still, investors’ slightly more risk averse attitude boosted demand for the “safe-haven” of the USD. Second, European officials strengthened their rhetoric against the strengthening EUR.
ECB member Quaden said "we have to avoid brutal movements" in foreign exchange. The ECB has often used “brutal” to signal displeasure with currency movements.
ECB President Trichet last used the term in late 2007, when EUR/USD was on its way to a record high.
Against the firmer USD, EUR was knocked from 1.4000 to just below 1.3900, GBP/USD drifted from 1.5950 to nearly 1.5880 and the downtrend in USD/JPY stalled at 82.00. Looking ahead, we wouldn’t be surprised to see further consolidation in the USD in the short-term, as investors further trim sizeable short positions.
A speech from The Fed’s Hoenig (a known hawk) tonight is unlikely to provide a trigger for USD selling. Additional event risk will come from September UK CPI and tomorrow morning’s FOMC minutes.
* Mike Jones is part of the BNZ research team.