Why the NZ$ fell and why it might drop to 78 Aussie cents

By Mike Jones

The NZD has been the weakest performing currency over the past 24 hours.

Still, at around 0.7250, NZD/USD is only slightly below where it was this time yesterday. A one-two punch from the RBNZ knocked some of the steam out of the currency yesterday, despite the expected 25bps rate hike being delivered.

Not only did the RBNZ lambast the NZD’s recent gains as “inconsistent with the softening in NZ’s economic outlook”, but its admission that “the pace and extent of further OCR increases is likely to be more moderate” pulled some of the yield support from under the NZD.

Falling 3-year swap rates saw the spread to the US equivalent narrow by 6bps to 323bps, while NZ-AU 3-year swap spreads slipped 8bps to -75bps.

NZD/USD slipped ¾ cent to 0.7200, and NZD/AUD fell ½ cent to 0.8080 accordingly.

It’s worth noting, our valuation model suggests room for NZD/AUD to fall further in the short-term.

Reflecting the recent slide in NZ interest rates, the model currently estimates a NZD/AUD short-term “fair-value” range of 0.7800-0.8000. Overnight developments provided some respite for the NZD. In particular, a bout of broad-based USD weakness lifted the NZD/USD off its lows, in tandem with most of the major currencies. Fears about the US losing its AAA rating weighed on the USD, after ratings agency Moody’s called for a “credible fiscal plan” from the US government.

The NZD also found some support from a decidedly perky AUD, amid market chatter of heavy month-end demand. Looking ahead, we suspect sentiment towards the USD will remain the key driver of the NZD/USD in the short-term. We wouldn’t rule out a near-term test of the 2010 high of 0.7440, should the recent bout of USD weakness continue. Nonetheless, we find ourselves a little cautious on the prospect of further substantial NZD/USD gains.

Our year-end target remains 0.7300.

Majors

USD weakness was the overriding theme in currency markets overnight. Indeed, the USD trade-weighted index slipped to 3-month lows around 81.60. A couple of factors contributed to the softer USD. First, a top official from ratings agency Moody’s highlighted the risks to the US government’s AAA rating, saying a “credible” plan to tackle its debt burden was needed.

10-year US government bond yields ticked up 3bps to 3.01%. In addition, a solid batch of European economic data again provided a contrast with the recent slowdown in US growth momentum.

The German unemployment rate fell for the 13th straight month in July (from 7.7% to 7.6%), as expected. And a surprising gain in European economic confidence (to 101.3 vs. 99.1 expected) provided more evidence of a pick-up in Eurozone economic activity. EUR/USD jumped from below 1.3000 to almost 1.3100, a 2½ month high, helped by a further widening in EU-US interest rate spreads.

The EU-US 2-year swap spread has rebounded from 0bps to nearly 70bps over the past two months, as economic momentum has switched in favour of the Eurozone.

The major currencies’ gains against the USD were accelerated by rumours of heavy month-end USD selling by funds readjusting their currency hedges. In particular, the AUD/USD was one of the night’s strongest performing currencies, rising from 0.8920 to almost 0.9040 amid rumours month-end AUD buying could total up to A$7b.

GBP/USD likewise remained perky, climbing roughly ½ cent from 1.5600 to 1.5650. This was despite June’s money supply measures confirming money growth is still weak in the UK.

Unless we see the monetary aggregates move convincingly higher in the coming months we believe underlying inflationary pressure in the UK will remain well contained for some time. There was relatively little direction for currencies from equity markets.

While earnings results out of the US and Europe were generally positive, an early rally ran out of puff into the close. European bourses are down 0.1-0.7%, while the S&P500 and the Dow Jones are both roughly unchanged. Looking ahead, near-term prospects for the USD rest with tonight’s all important Q2 US GDP data (market expectations +2.7%, annualised).

Further disappointment on the strength of the US economy could see the USD index test support around 81.20. Resistance is eyed towards 82.30.

* Mike Jones is part of the BNZ research team. 

All its research is available here.

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