Opinion: NZ$ falls below 71 USc as markets watch Dubai debt default

By Mike Jones The NZD ended last week on a fragile footing. After climbing above 0.7350 at one point, NZD/USD finished the week closer to 0.7100. Concerns about contagion effects from Dubai's request for a "stand still" on debt repayments were the dominant driver of currency markets towards the end of last week. The S&P500 fell 1.7% on Friday as US markets reopened after Thanksgiving. Our risk appetite index (which has a scale of 0-100%) fell nearly 10 percentage points (to 48.5% from 58%) - the largest daily fall since the Lehman's collapse in September 2008. While a move of this order is probably overstated (due to holiday thinned trade on Friday), it is indicative of how fragile market sentiment is at present. Plummeting risk appetite took a toll on "˜growth-sensitive' currencies like the NZD and AUD as investors sought out the relative "˜safe-haven' of the USD and JPY. USD/JPY fell below 85.00 on Friday night "“ the lowest level since 1995. The broadly stronger JPY saw NZD/JPY finish the week down nearly 4.5%.

Selling was reportedly exacerbated by Japanese margin accounts being forced to square up long positions. While the weaker NZD/JPY was a notable drag on the NZD last week, losses were still fairly broad-based. Indeed, the NZ TWI was down over 2% for the week. The week ahead is fairly quiet on the data front. Today's building consents for October will likely show further trend recovery on the housing side. Thursday's commodity export prices are bound to show clearer improvement for November, as the further gains in international dairy prices are logged and the currency, in moderating, turns friend for the month, rather than remaining foe. Also watch for Friday's Crown accounts, for October. In terms of near-term NZD direction, much will depend on how sentiment in offshore markets evolves in response to the situation in Dubai. In particular, what the response from the Abu Dhabi sovereign will be. For now though, the downside momentum in the NZD looks to be well established. Elevated risk aversion and reduced technical support should also act to keep the NZD heavy in the short-term. The key level to watch is 0.7080. A daily close below this would suggest a deeper correction is on the cards. The USD and JPY found further support on Friday as concerns about a Dubai debt default continued to ripple through global markets. Last week's announcement from Dubai that it will ask for a debt repayment "stand still" had the expected effect on US markets on Friday (markets were closed on Thursday for Thanksgiving). The S&P500 closed down 1.7%, after retreating as much as 2.4% in early trade, as markets fretted over US and European bank exposures to Dubai. The VIX index (an index of S&P500 volatility used as a proxy for risk aversion) spiked from 21% to nearly 26%. And US 2-year Treasury yields fell to the lowest level this year (0.61%). As a result, demand for the USD and JPY continued to firm as rising risk aversion saw investors flock back into assets regarded as a "safe-haven". However, moves may have been exaggerated somewhat by reduced liquidity (the Friday after Thanksgiving is taken as a holiday by many). EUR and GBP continued to slide, reaching 1.4850 and 1.6300 respectively. Meanwhile, USD/JPY fell below 85.00 at one stage during the night, the lowest level since 1995. However, speculation about Japanese currency intervention later stymied gains in the JPY, paving the way for a stabilisation in the USD. Japanese Finance Minister Fuji raised the prospect of issuing a G7 joint statement on currencies "“ similar to the one issued in October 2008 "“ to help slow the ascent of the JPY. The Bank of Japan also reportedly checked exchange rates with commercial banks "“ a move that has coincided with JPY intervention in the past. In the wake of these developments, USD/JPY rapidly pared earlier losses rising to 86.50, and most of the major currencies followed suit. Easing fears about Dubai contagion effects may have also contributed to the stabilising USD and JPY. A senior official reported that Abu Dhabi may assist in underwriting some of Dubai's debt on a "pick and choose" basis. And the Central Bank of the United Arab Emirates said it will provide extra liquidity for both domestic and foreign banks. Looking ahead, as markets assess the possible "˜damage' from troubles in Dubai, and investors remain generally risk averse, we'd expect both the USD and JPY to remain well supported in the near-term. However, markets will likely return to data watching later this week with plenty of important releases on the horizon. US non-farm payrolls on Friday will be the highlight. The US ISM manufacturing index and Chinese and European PMIs will also be closely watched. This week also brings interest rate decisions from both the RBA and the ECB. * Mike Jones is a BNZ Currency Strategist. All of the research produced by the BNZ Capital team of economists is available here.