By Mike Jones
After skirting 8-month highs of nearly 0.7400 early last week, the NZD/USD subsequently ran out of puff.
Global market conditions provided clear tailwinds for the NZD last week. Upbeat economic news out of China and Europe kept risk appetite on the front foot. The MSCI World Equity Index rose 1.5% over the week to 4-month highs and our risk appetite index (which has a scale of 0-100%) tracked up to nearly 60%.
At the same time, sentiment towards the USD deteriorated noticeably as speculation the Fed could loosen already mega-loose monetary policy sent US bond yields tumbling. Against a broadly weaker USD, the EUR/USD climbed nearly 3% over the week and AUD/USD was launched to 25-month highs above 0.9450.
However, flagging support from the domestic backdrop ensured the NZD underperformed. Not only did July retail sales disappoint, but the RBNZ’s notably dovish September MPS also weighed on the currency. The RBNZ slashed around 120bps worth of tightening off their interest rate forecasts, causing yield-hungry investors to take flight from the NZD. After coming within a whisker of 8-month highs around 0.7400 on Tuesday, the NZD/USD finished the week closer to 0.7260.
The key event in the coming week will be the FOMC policy announcement on Tuesday. Investors will be on the look out for any hints the Fed may restart quantitative easing. On the local front, keep an eye out for Thursday’s NZ Q2 GDP figures. These look set to undershoot the Reserve Bank’s 0.9%q/q estimate. We are looking for 0.5%, with the consensus at more like 0.8%.
We’re also bracing for an increase in the Q2 current account deficit (to about 2.8% for the year to June 2010, from 2.4%) when June balance of payments figures are released on Wednesday.
All up, we suspect the weight of uninspiring NZ economic news and the prospect of a rebound in the USD will keep NZD/USD rallies limited to 0.7330 this week. Initial support is eyed on dips towards 0.7145.
The USD strengthened against most of the major currencies on Friday. Still, over the week, the USD index fell just over 1.5% – the biggest weekly decline since July. Early in the night, appetite for ‘risk-sensitive’ currencies was underpinned by a string of upbeat earnings reports and gains in equity markets. US software firm Oracle reported better-than-expected Q2 profits, helping the S&P500 open around 0.6% higher.
Against a backdrop of rising risk appetite, investors ditched “safe-haven” currencies like the USD in favour of EUR and AUD. Amid solid demand from real money and sovereign accounts, EUR/USD climbed from 1.3080 to nearly 1.3160 and AUD/USD soared to 25-month highs above 0.9460.
However, later in the night, the USD and stocks reversed course as rising European sovereign debt fears and more uninspiring US economic data knocked risk appetite. Irish sovereign CDS spreads (a measure of default probability) spiked 30bps to record highs above 420bps amid newspaper reports an IMF bailout was needed for Ireland. Despite reassurances from the IMF this was not the case, European stocks closed down 0.6-1.2% and EUR/USD skidded from 1.3160 to around 1.3050.
The sentiment U-turn was reinforced by an awful reading of the University of Michigan US consumer confidence survey (66.6 vs. 70.0 expected). US stocks reversed most of the earlier gains and gold prices surged to fresh all-time highs above US$1282/ounce. The Baltic Dry Index (an indicator of world trade based on shipping costs) slipped 2.2% and oil prices declined 1.2% to US$73.50/barrel. Renewed global growth worries saw the USD bounce back as demand for “safe-haven” assets returned.
As a result, the AUD/USD eased off its highs and USD/CAD jumped from 1.0220 to around 1.0330. Looking ahead, Wednesday morning’s (NZT) FOMC policy announcement looks set to dominate market attention this week, particularly given mounting speculation the Fed could soon announce additional quantitative easing measures (QEII). We suspect it will take further clear deterioration in US economic data for the Fed to consider such drastic action.
As such, there is unlikely to be much change in the Fed’s language this week. If we’re right, a mild bounce in US bond yields and the USD could be in the offing. This is particularly so given short positions in the USD reached the highest level in a month last week. Elsewhere, renewed fears over European sovereign solvency means Tuesday’s sovereign debt auctions in Greece, Spain and Portugal will also be worth watching.
* Mike Jones is part of the BNZ research team.