By Mike Jones
The NZD has started the week on the back foot. Despite relatively upbeat local data, the NZD/USD has fallen nearly a cent over the past 24 hours as the worsening European sovereign debt crisis continues to suppress investors’ risk appetite.
The economy continues to push forward, judging by yesterday’s NBNZ business survey. Indeed, there was even a hint of acceleration in the survey’s confidence and activity indicators.
The lift in the activity outlook, to 33.1 from 26.9 (seasonally adjusted), is certainly in keeping with our forecast of stronger NZ economic growth through 2011. Still, as we noted yesterday, the focus for the NZD remains firmly in Europe. As such, the NZD/USD barely flickered following the survey’s release.
Overnight, a clear deterioration in the European sovereign debt crisis kept “risk-sensitive” assets like the NZD under pressure. The provision of an €85b bailout package for Ireland appeared to do little for sentiment, as investors worried about the risk of Ireland’s debt woes spreading to Italy, Portugal and Spain.
Indeed, European sovereign borrowing costs increased to fresh all-time highs in many cases, knocking European equity markets for six. With heavy EUR/USD selling contributing to a broadly stronger USD, the NZD/USD was knocked from 0.7530 to around 0.7450. At the same time, widespread EUR cross selling propelled NZD/EUR from 0.5650 to closer to 0.5700.
Of note, the recent slide in the NZD/USD has been broadly consistent with “fundamentals”.
Indeed, according to our short-term NZD/USD valuation model, NZD/USD “fair-value” slipped around 2 cents last week. While the cooling in global risk appetite has certainly contributed to such, NZ-US 3-year swap spreads also dropped around 15bps over the past week (to 318bps).
Reflecting these developments, the model now suggests a 0.7400-0.7600 “fair-value” range in NZD/USD. Should risk aversion continue to befoul global sentiment, we could see the NZD/USD push through the bottom end of this range this week.
For today, initial support is eyed towards 0.7400.
Most of the major currencies lost ground against the USD overnight, as the European sovereign debt crisis continued to crimp investors’ appetite for risk.
Yesterday’s decision by Ireland to accept the €85b bailout package offered by the EU-IMF had only a fleeting positive impact on market sentiment. The knee-jerk reaction saw the EUR/USD jump from 1.3240 to almost 1.3350. However, EUR selling returned with a vengeance overnight, as worries about Irish contagion to the rest of peripheral Europe returned.
An Italian sovereign bond auction attracted only lacklustre investor demand, spurring renewed fears about debt refinancing. Two-year Italian bond yields surged nearly 40bps to 2.90% in response. Meanwhile, CDS spreads (an indication of the cost of default insurance) on Portuguese and Spanish sovereign bonds rose to new record highs.
EU Commissioner Rehn said “Portugal needs to assure stronger fiscal consolidation continuing in 2012”, while US economist Nouriel Roubini said “perhaps it could be a good idea (for Portugal) to ask for a bailout in a preventative fashion."
Heavy selling of EUR crosses, most notably EUR/CHF and EUR/GBP, eventually saw EUR/USD tumble from 1.3300 to a 2-month low below 1.3100. Most of the other major currencies were dragged lower in the EUR’s wake, contributing to a broadly stronger USD. GBP/USD slipped from 1.5640 to around 1.5560 and USD/JPY ground up from below 84.00 to closer to 84.40.
Heightened risk aversion and concerns about European sovereign solvency also took a clear toll on global equities. European stock indices plunged 2.1-2.5%, the largest daily fall since June. US equities followed suit. The S&P500 slipped around 1.0%, while the Dow Jones index recorded a near 1.2% decline. The week ahead is crammed full of event risk.
A busy week for US data features the release of the ISM manufacturing survey on Wednesday and non-farm payrolls on Friday.
Fed Chairman Ben Bernanke is also due to speak on Wednesday. Elsewhere, European and Chinese PMIs, Australian Q3 GDP, and the latest ECB policy announcement also have the potential to promote volatility.
Nevertheless, rather than relative fundamentals, we suspect gyrations in global risk appetite and the fortunes of the EUR will remain the key drivers of currencies this week. As markets continue to fret over Irish contagion, we wouldn’t be surprised to see further declines in the EUR/USD. The next key support level is eyed around 1.3000.
* Mike Jones is part of the BNZ research team.
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