Opinion: US$10 bln Dubai bailout underpins NZ$ at just under 73 USc

By Mike Jones The NZD has started the week on a relatively firm footing. Improving risk appetite and a slightly softer USD has seen NZD/USD push up to nearly 0.7300 over the past 24 hours. Yesterday's announcement from Abu Dhabi that it will provide US$10b in funds to bail out Dubai underpinned investors' risk appetite overnight. Global stock markets were also cheered by the news "“ European equity indices are up 0.8-1.0% and the S&P500 is currently 0.6% in the black. News Citigroup will pay back around $US17b worth of government bailout money and M&A activity may again be on the rise (following Exon Mobil's US$31b bid for XTO Energy) were also seen as positive. Our risk appetite index (which has a scale of 0-100%) is sitting at 56%, well above the long-run average of 50%.

As demand for "˜riskier' assets improved, investors went back to selling the USD and buying "˜growth-sensitive' currencies like the NZD. NZD/JPY surged from 63.80 to 64.60 in the wake of the Dubai announcement and this paved the way for more broad-based NZD gains later in the night. In fact, the NZD/USD continued to outperform most of its peers as both real money and sovereign accounts continue to show solid appetite for the NZD. A 0.8% lift in the CRB index (a broad measure of global commodity prices) also supported demand for commodity currencies like the NZD. Locally, today brings the Government's Half-Year Economic and Fiscal Update (HYEFU). Compared to the last update the economic situation has improved materially. So expect to see Treasury bolster its forecasts, which should help forward revenue and thus the overall accounts. However, it will be a firmer recovery from a much worse than expected near-term position; a bigger hole to dig our way out of in other words. So watch out for the HYEFU's current-year (2009/2010) fiscal deficit estimates to be enlarged from the Budget track. Across the Tasman, the RBA's December Board minutes will also be released today at 1.30pm (NZT). We suspect the NZD will remain well supported over the week ahead. In our view, the post-RBNZ widening in NZ-US interest rate spreads should keep NZD/USD dips limited to 0.7200 in the near-term. The USD weakened against most of the major currencies overnight as news of Abu Dhabi's bailout plan for Dubai reduced demand for the USD as a "˜safe-haven'. The Abu Dhabi Government announced it will provide US$10b in funding to help Dubai repay a US$4.1b Islamic bond (owned by troubled developer Nakheel). The remaining funds are to be used to cater for Dubai World's interest payments and working capital requirements until April next year. The announcement helped allay concerns over a possible Dubai default, as well as sovereign debt fears more generally. The positive sentiment was quickly reflected in equity markets. The Dubai stock index rose 10% on the news, the DAX finished 0.8% higher and the S&P500 is currently up 0.6%. US stocks received a further boost from Citigroup's announcement it will repay US$17b worth of government bailout money and speculation M&A activity is growing (Exxon Mobil said it will buy XTO Energy for around US$31b). The VIX index (an indicator of risk aversion based on volatility of the S&P500) fell below 21% from around 21.5%. Firming risk appetite and modest gains across equities markets saw the USD erase some of its recent gains as "˜safe-haven' positions were pared back. Of the major currencies, gains were most marked in the JPY following yesterday's better-than-expected Japanese Tankan survey. Most of the survey's measures were not quite as weak as feared; the headline manufacturing index rose to -24, against the -27 expected. USD/JPY dived to nearly 88.40 in the immediate wake of the data and largely tracked sideways through the rest of the night. Despite the slightly softer USD, EUR/USD really just chopped a sideways range around 1.4650 last night. Eurozone industrial production data wasn't particularly inspiring (-11.1%y/y vs. -10.8% expected) and sovereign debt concerns in the region remain elevated as a result of Greece's recent downgrade. Looking ahead, the next key hurdle for the USD will be the FOMC rate decision on Thursday morning. Recent moves in Fed market pricing suggest a more upbeat statement will be needed from the Fed for the USD to hold onto recent gains. US housing starts, building permits, industrial production and the Philadelphia Fed index will shed further light on the US outlook. Australian Q3 GDP, UK retail sales and the Bank of Japan meeting will also be worth watching. Ahead of the FOMC, and while markets remain a little uncertain about near-term USD drivers (trends in risk appetite versus US interest rates), we'd expect the USD index to chop around a familiar 75.50-76.80 range. * Mike Jones is a BNZ Currency Strategist. All of the research produced by the BNZ Capital team of economists is available here.