Opinion: NZ$ drops below 72 USc on talk of later OCR hike and China lending crackdown

By Danica Hampton The NZD has been hit by a "˜perfect storm' of negative news over the past 24 hours. In fact, the NZD has been the weakest performing currency amongst the majors. NZD/USD has fallen almost 3% to a touch below 0.7200 "“ the largest daily drop since November. The NZD's woes began with yesterday's CPI data for Q4. Not only did the headline figure fall 0.2% (compared to market expectations of flat), but the details told of quite soft inflation under the surface. This certainly aligned with our view the RBNZ can wait until mid-year to begin tightening "“ something the Bank itself indicated in its December Statement. The softer data tended to pour cold water over the earlier hikes the market had priced in, and interest rates and the NZD fell sharply as a result. Two-year swap rates fell around 10bps and the NZD/USD dropped to 0.7350. Headlines suggesting Chinese banks have been told to halt new lending for the rest of January had the effect of kicking the currency when it was down. Overnight, a spike in risk aversion and a broadly stronger USD saw the NZD/USD continue on its path southwards. Global equity markets have plunged 1.5-3.0% over the past 24 hours, weighed down by the news of China's surprise lending restrictions and some relatively lacklustre earnings reports from Morgan Stanley and Bank of America. Our index of risk appetite (which has a scale of 0-100%) has slumped from 68% to 63%. The slide in risk appetite prompted increased demand for "˜safe-haven' currencies like the USD and JPY, at the expense of EUR, AUD and NZD. In addition, increased appetite from speculative and leveraged accounts to sell NZD against AUD, USD and JPY added to selling pressure, such that NZD/USD eventually reached a year-to-date low of around 0.7190. We suspect NZD/USD will remain a little heavy in the short-term. But, for near-term direction, watch out for today's November retail sales data (+0.5%m/m expected) and the slew of Chinese data due out at 3pm. A spike in risk aversion has seen the USD strengthen against all of the major currencies over the past 24 hours. Gains in the USD were initially spurred by talk China was taking further action to tighten liquidity. Rumours hit the wires yesterday afternoon that the People's Bank of China had instructed several large Chinese banks to halt lending for the rest of January, after a reported 1.1 trillion yuan (US$161b) was lent over the first half of the month. The news tended to hit commodity-linked currencies like NZD and AUD the hardest on fears slowing Chinese growth could dent demand for commodities. Not surprisingly, the news also took a toll on commodity prices. The CRB index (a broad measure of global commodity prices) has fallen around 1.4%. Overnight, stock markets around the world were pummelled. The Shanghai index fell nearly 3%, the DAX declined 2.1% and the S&P500 is currently down around 1.5%. Asian and European markets were weighed down by news of China's lending crackdown, while US markets also grappled with some poor earnings reports. Both Bank of America and Morgan Stanley reported worse-than-expected Q4 profits (offset to some extent by solid earnings from Wells Fargo and US Bancorp). A relatively conservative 2010 outlook from IBM also weighed. The VIX index (a measure of equity market volatility used as a proxy for risk aversion) soared from 17.5% to above 19.5% - its biggest one day rise in nearly two months. As risk appetite faltered, investors rushed back in to "˜safe-haven' currencies like JPY and USD, even as US interest rates fell. Concerns about the solvency of Greece continue to hang over EUR. Combined with the stronger USD and heavy selling by speculative accounts, this saw EUR/USD fall to a 5-month low below 1.4100 last night. In contrast, GBP has been relatively insulated from the carnage in currency markets over the past 24 hours. The Bank of England's January MPC minutes were relatively bland. But a surprise drop in the ILO measure of unemployment, to 7.8% (analysts had expected a tick up to 8.0%) restricted losses in GBP/USD to around 1.6260. Last night's batch of US data was mixed, and generally off the radar for currency markets. December housing starts were a touch weaker than expected (-557,000 vs. 572,000 expected), offset by slightly firmer building permits (653,000 vs. 580,000 expected). Producer prices increased 0.2% in December, compared to flat expectations. * Danica Hampton is BNZ's Senior Currency Strategist. All of the research produced by the BNZ Capital team of economists is available here.