Opinion: Investors flee riskier currencies after Dubai debt shock spooks markets

By Danica Hampton After climbing above 0.7300 yesterday morning, NZD/USD plunged sharply last night. Fears about a Dubai debt default rocked markets last night. The Dubai government said it intends to ask Dubai World's (a state-run company) creditors for a "˜stand still' on debt payments. In the wake of the news, Standard & Poor's and Moody's downgraded the credit ratings of several government-related entities. While US markets were closed for the Thanksgiving holiday, European equity indices fell 3-3.5% - the largest daily loss in about seven months. The backdrop of falling equities and risk aversion saw investors shun growth-sensitive currencies like NZD in favour of the relative safety of the USD and JPY.

USD/JPY plunged from around 87.50 to nearly 86.30 "“ its lowest level since May 1995. The sharp strengthening of JPY didn't go unnoticed, Japan's Finance Minister warned the government would take action to guard against "abnormal" currency moves. NZD/JPY skidded from around 63.50 to below 62.00 and NZD/USD was dragged below 0.7150. There was nothing in yesterday's National Bank business survey to get financial markets excited. It confirmed our view that, slowly but surely, the New Zealand economy is pulling itself from the mire. The best evidence that economic growth should accelerate from here was the news that businesses' own activity assumptions again edged higher to their strongest level (on a seasonally adjusted basis) since November 2002. This is entirely consistent with our view that the annual expansion in GDP will climb above 3.5% by the end of next year. While a solid expectation, it's worth noting that this is a view already shared by the RBNZ and so yesterday's data is a reason to bring forward the expected tightening cycle. For today, the backdrop of weak global equities and risk aversion should ensure bounces in NZD/USD are limited to 07200-0.7220. Initial support eyed around the overnight low of 0.7130, but the key level to watch is 0.7080 (the lows from early November). A break below 0.7080 would suggest a deeper a correction is on the cards. The USD and JPY rose sharply last night as concerns about a Dubai debt default spooked investors worldwide. Dubai said it intended to ask "all providers of financing to Dubai World and Nakheel to "˜stand still'" its debt payments while it restructures the company. Dubai World is a state-run company that has about US$59b worth of liabilities and Nakheel is its subsidiary. In the wake of the government announcement, rating agencies Standard & Poor's and Moody's both downgraded the credit ratings of several government-related entities. The Dubai debt problems put financial markets in a tail-spin, global equities plunged and "˜safe-haven' demand saw bond yields drop. While US equity markets were closed for the Thanksgiving holiday, European equity indices suffered their worst daily loss in seven months. The FTSE fell 3.18% and the DAX dropped 3.25%. Plunging equities and sky-rocketing risk aversion saw investors shun "˜growth sensitive' currencies in favour of the relative safety of the USD and JPY. On a trade-weighted basis, the USD has climbed more than 1% in the past 12 hours. USD/JPY plunged from around 87.50 to nearly 86.30 "“ its lowest level since May 1995. Against this backdrop, EUR/USD dropped from nearly 1.5150 to around 1.4960 and GBP/USD skidded from above 1.6700 to below 1.6500. Japanese officials are clearly concerned about the 14-year low in USD/JPY. Japan's Finance Minister said the government needs to take action on "abnormal" currency movements. If USD/JPY remains heavy we're likely to hear more of this verbal intervention. However, the general feeling amongst market participants that intervention isn't imminent just yet. Despite the rush to "˜safe-haven' currencies, the CHF remained fairly weak. USD/CHF rose from sub-0.9950 to above 1.0070 amid speculation the Swiss National Bank (SNB) had intervened to weaken the currency. USD/CHF fell below parity yesterday after SNB Chairman Roth hinted that the improving economy warranted tighter monetary conditions. As year-end approaches, investors will start to pay more attention to the prospects for 2010. Given equities looked stretched relative to valuations, and the worries about the global economy will cope as policy makers scale back their massive policy stimulus measures, equity markets may remain vulnerable. In the near-term, expect currencies to take cues from global sentiment and risk appetite. While equity markets remain weak and investors risk averse, we'd expect both the USD and JPY to remain underpinned. * Danica Hampton is BNZ's Senior Currency Strategist. All of the research produced by the BNZ Capital team of economists is available here.