By Mike Jones*
The NZD was the weakest performing currency last week.
After starting the week around 0.7850, a collapse in global risk appetite sapped demand for “growth-sensitive” currencies like the NZD, and the currency finished the week closer to 0.7500.
Rising global risk aversion was the dominant theme in currency markets last week. Not only did investors fret about the likelihood of contagion from Ireland’s debt worries to the rest of Europe’s periphery, but news of North and South Korea exchanging artillery fire contributing to rising geopolitical tensions.
The MSCI World Equity Index shed around 2% over the week and our own risk appetite index (which has a scale of 0-100%) slumped almost 10 percentage points, to 60.4%. As a result, investors shunned “risk-sensitive” currencies like the AUD and NZD in favour of the relative safe-haven of currencies like the JPY, CHF, and USD.
Add S&P’s surprise NZ ratings outlook downgrade into the mix and the recipe for the NZD’s underperformance was complete. Its worth noting, last week’s slide in the NZD/USD appears to have been broadly consistent with “fundamentals”. Indeed, according to our short-term NZD/USD valuation model, NZD/USD “fair-value” dropped around 2 cents last week.
While the cooling in global risk appetite certainly contributed to such, NZ-US 3-year swap spreads also dropped around 15bps over the week (to 318bps).
Reflecting these developments, the model now estimates a 0.7400-0.7600 “fair-value” range in NZD/USD. Should risk aversion continue to befoul global sentiment (watch Irish bailout news and developments on the Korean peninsula), we could see the NZD/USD head towards the bottom end of this range this week.
Initial support is eyed towards 0.7430. This afternoon’s NBNZ business survey will set the tone for the NZ data week.
We expect it to largely hold up, which is what our own BNZ confidence survey has already suggested for November’s business mood. Majors The USD strengthened against most of the major currencies on Friday as rising risk aversion encouraged demand for “safe-haven” assets.
On a trade-weighted basis, the USD finished the week 2.3% stronger. Nervousness about the European sovereign debt situation continued to undermine investors’ risk appetite on Friday. Some respite was provided by news an EU-IMF bailout deal for Ireland would be announced sometime today.
But worries Ireland’s debt woes could spread to Spain and Portugal kept equities markets and risk sensitive currencies on the back foot. The Financial Times reported that European policy makers are now pushing Portugal to seek EU-IMF aid (a rumour that was later denied), and Spain was also in the headlines for all the wrong reasons.
The Spanish prime minister even warned those speculating on a Spanish default “are going to be wrong.”
The spread between Spanish and German 10-year bonds widened out to a fresh all-time high around 260bps, with most other peripheral funding spreads widening in sympathy. European equity markets recorded declines of 0.5% (German DAX) to 1.8% (Spanish IBEX), dragging US equities indices 0.3-0.9% lower.
The VIX index (a proxy for risk aversion) surged from 19% to almost 22.5%. Against this backdrop, investors scrambled back to the relative “safe-haven” of currencies like the JPY, CHF and USD. In contrast, global growth-sensitive currencies like the AUD, NZD and CAD were widely shunned.
Reflective of mounting Irish contagion worries, the EUR/USD finished the week over 3% weaker, briefly hitting a 2-month low below 1.3200 on Friday.
Looking ahead, 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 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, we suspect gyrations in global risk appetite, rather than economic fundamentals, will remain the key driver of currencies this week. In this regard, keep an eye on an announcement on the details of the €85b EU-IMF Irish sovereign bailout (due today sometime), and developments on the Korean peninsula. The US and South Korea commenced military exercises off the Korean coast on Sunday.
* Mike Jones is part of the BNZ research team.
All its research is available here.
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