Opinion: NZ$ back back over 67 USc after Fed's benign outlook

By Danica Hampton The past 24 hours have been a real roller coaster ride for NZD/USD. A melt-down in Asian equities (most Asian indices fell 3-4.5% yesterday) sparked more doubts about the speed of the Asian recovery and the global outlook. Investors ditched growth sensitive currencies like NZD in favour of the relative safety of the USD and JPY. NZD/JPY fell from 64.00 to below 63.00 and NZD/USD was dragged below 0.6600. However, NZD/USD didn't linger around these levels for long. European and US equity markets opened higher and the negative sentiment quickly evaporated. A bout of short-covering (where investors squared up their recently entered short NZD positions) pitched the currency higher and NZD/USD was soon sitting back above 0.6700. The FOMC decision was largely in line with expectations. The Fed left their policy rate unchanged at 0-0.25% and reaffirmed that "economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period". The statement struck a slightly more positive tone than its last statement. And while the Fed left the size of quantitative easing program unchanged, it said it would "gradually slow" the pace of its US Treasury purchases. The Fed's decision not to expand its quantitative easing program meant the statement was initially treated as mildly USD positive by the market. As such, the NZD/USD fell just under half a cent following the statement's release to around 0.6700. However, the USD uptrend ran out of steam and NZD/USD is now sitting back at around 0.6750. Looking ahead, while investors remain relatively confident about the global recovery and risk appetite stays solid, we'd expect NZD/USD to remain underpinned. Consistent with the improvement seen in the global manufacturing sector, today"˜s NZ Business PMI should recover from June's 46.2. For today, provided Asian equities remain relatively solid, we'd expect dips in NZD/USD to be limited to 0.6650-0.6660 region. It's been a wild night in currency markets. The first half of the night was dominated by risk aversion. Asian equities plunged 3-4.5% yesterday and this triggered a major bout of "safe-haven" demand for USD and JPY. NZD/USD skidded to around 0.6600, GBP/USD fell below 1.6400 and EUR/USD was dragged down to around 1.4080. However, risk appetite improved through the second half of the night. There were few signs of hope in the Eurozone data (industrial production fell 17%y/y), but June's US trade deficit was marginally better than expected (it fell to US$27b vs. US$28.7b forecast). Nonetheless, European and US equities chalked up modest gains and this was enough to trigger a violent squeeze as markets waited for the FOMC decision. All the earlier strength in USD and JPY was quickly reversed "“ EUR/USD climbed from sub-1.4100 to around 1.4240 and GBP/USD rose from below 1.6400 to above 1.6550. As widely expected the Fed left the policy rate unchanged at 0-0.25% and reaffirmed that "economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period". The Fed noted that "economic activity is levelling out", which was slightly more upbeat than June's comment that "the pace of economic contraction is slowing". Consistent with this slightly more upbeat tone, the Fed left the size of quantitative easing program unchanged and said it would "gradually slow" the pace of its US Treasury purchases. In the immediate wake of the FOMC statement, the USD strengthened across a broad range of currencies. Macro accounts were noted buyers of USD and EUR/USD plunged from 1.4240 to around 1.4120. However, the uptrend in the USD quickly ran out of steam. Before long, EUR/USD was sitting back around 1.4220. There was little reaction in US interest rate markets. US 10-year yields are still sitting around 3.70% and money markets are still consistent with the first Fed hike coming in January. While it's been a violent 24 hours in currency markets, squint your eyes through the volatility and it's easier to see that nothing fundamental has really changed. Investors continue to think the global economy is on the road to recovery, global equities remain firm and risk appetite solid, we suspect the USD Index will struggle to push above the 79.66 high reached on July 29. * Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Capital team of economists is available here.