By Mike Jones
It was a rocky road higher in the NZD/USD last week.
After starting the week around 0.7450, the NZD/USD spent most of the week grinding choppily higher, to eventually reach an 11-month high of nearly 0.7600. Further evidence of a fizzling domestic recovery had little impact on the NZD last week.
Instead, a broadly weaker USD underpinned the NZD/USD as US markets became convinced the US Federal Reserve will soon embark on quantitative easing Mark II. Friday’s lacklustre US non-farm jobs report simply reinforced this trend.
The impact of the weaker USD was marked. Gold prices soared to record highs, USD/JPY fell to 15-year lows, and the EUR/USD and AUD/USD climbed to 8-month and 27-year highs respectively.
While the NZD/USD was also a reluctant recipient of last week’s USD fire sale, it is notable that the NZ TWI barely moved last week and remains 2.9% below May’s 2010 high. Looking ahead, there is no doubt the NZD/USD is starting to look overstretched on the basis of economic ‘fundamentals’.
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 ensure any NZD/USD dips are limited 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.
Appetite for “growth-sensitive” currencies like the NZD and AUD is likely to remain firm early in the week as a result. This week’s mostly second tier offering of NZ economic data means the focus for the NZD will remain offshore.
Still, today’s electronic card transactions may be useful in providing early insight into the negative impact of the Canterbury earthquake as well as any pre-GST spend up.
Friday’s US non-farm payrolls employment report was weak, no two ways about it. Both headline and private sector jobs came in below market expectations (headline -95k vs. -5k expected; private sector 64k vs. 75k expected).
With USD sentiment already in the doldrums, confirmation of the fragile state of the US labour market simply provided another excuse to sell the USD. US bond yields declined in the wake of the report, dragging the USD lower against all of the major currencies. The 2-year US Treasury yield slipped to a fresh all-time low below 0.34% and the USD index closed out the week 1.0% lower – the fourth consecutive weekly decline.
Reflecting the broadly weaker USD, gold prices surged to a new record high above US$1345/ounce, USD/JPY dived to 15-year lows below 82.00 and the EUR/USD briefly flirted with 1.4000. Later in the night, Eurogroup chairman Juncker hit the wires suggesting the EUR is out of line with “underlying fundamentals”, knocking the EUR/USD from its highs. There was little for markets to get excited about from the weekend's IMF/G7 meetings.
As expected, there was a lot of chatter about the risk of “currency wars”, but little in the way of co-ordination or agreement. Japanese finance minister Noda set the tone on Friday, saying "we are approaching a G7 meeting, but regardless of this, Japan will take firm measures, including intervention, when needed." The IMF did, however, agree to produce a “spillover report”, which will assess the monetary policy, exchange rate, and capital flow linkages between the US, China, the UK, Japan and the Eurozone.
Not surprisingly though, analysts are a little sceptical about what impact the report will have. There was also the expected war of words between China and the US on the extent to which the Yuan should be allowed to appreciate but, once again, both nations appeared to agree to disagree for the meantime. The latest CFTC data shows USD net short positions amongst the speculative community increased 8% to US$31b last week.
Speculators now hold the largest short USD position since November 2007. Should this week’s US data throw up a positive surprise, a short-covering rally in the USD may well result. In this respect, the Fed’s FOMC minutes on Wednesday morning and Friday’s slew of US data will be worth keeping an eye on.
In the short-term, support on the USD index is expected on dips towards last week’s 76.90 low, with initial resistance around 77.90.
* Mike Jones is part of the BNZ research team.