Opinion: Kiwi$ solid, but wary of maturing Uridashis

By Danica Hampton As global markets continue to speculate that the worst recession in 70 years is behind us, risk assets and investments continue to prosper, albeit at levels we are familiar with in recent trading. Last night's calendar of earnings reports and US New Home Sales data continued to encourage the rose tinted view of the world economy. Real money investors were as much a part of the market flows as the model & leveraged players that we have often mentioned in this commentary of late. Earlier in the overnight session, improved German Consumer Confidence had encouraged risk sentiment, as the EUR traded towards the 1.4300 level and the AUD to within a whisker of 2009 highs above 0.8250. Across Asia and Europe there have been gains in most equity indices, while key US indices are close to flat, to start the week. There is some underperformance by the NZD to start the week, as it trades close to the 0.6550 level. Yesterday's session was clouded by concerns about maturing Uridashi and Eurokiwi investments that we've previously highlighted, though in some part it seems these investments are either being rolled over or any supply is meeting fresh demand from new investors. In the mix of factors impacting on the Kiwi is of course this week's RBNZ OCR announcement, and as we've mentioned with the NZD performance tightening policy there is a risk of some comment from the Governor "“ also in the mix was Australian media and politicians talking tighter monetary policy in Australia, which has encouraged some selling of the NZDAUD cross rate. Our opportunities to consider local data begin today with June merchandise trade figures. Imports probably fell faster than exports, y/y, with the expected monthly surplus ($215m) plenty enough to signal further contraction in the current account deficit, while helping to limit the fall we estimate for Q2 GDP to just 0.2%. The immediate base for the Kiwi remains at the 0.6500/0.6525 level and resistance is evident on moves towards the 0.6625/0.6650 window. This could be a decisive week for FX. With many equity indexes now above key technical levels, a continuation of the earnings upside surprise could easily continue the current equity rally, though the succession of multi-day gains will come to an end soon. We're far from convinced this mood can be sustained given the likelihood that the inventory rebound that is aiding earnings will be limited, and the fact that earnings are being supported by cost cutting. The number of companies revealing sales exceeding expectations was a more modest 50% compared to the 75% who have revealed earnings surprises. As inventory and economic stimulus effects ease and consumers hunker down to repay debt, earnings outlooks ought to reflect this. So we are concerned that G10 FX majors look over-extended versus the USD, are due a retracement and we would certainly not be surprised to see equities pare back recent gains that would set in train such an FX move. However, we seem to be at a fork in the road in the short-term and if earnings continue to look good, the call for a retracement might yet be one that emerges further down the road, leaving the USD vulnerable to a new wave of weakness as risk marches on. Adding to the FX market's hesitation is the knowledge that a number of central authorities could and in some instance would be drawn into a response; the SNB has in recent months been active with intervention in the CHF market for example. The RBNZ and BoC have both commented on the strength of their currencies. Last week the BoC said the rise in the CAD was significantly moderating the pace of overall growth were it to continue and though it did not repeat its June assertion that the CAD could fully offset positive factors, the risks are clear. In June the RBNZ said the recent rise in the NZD created an unhelpful tension in its projections, risking delaying or even reversing the projected increase in exports and putting the recovery at risk. The RBNZ Governor has repeated this line in July and we expect the Bank to reassert its caution on the NZD in this week's post-meeting statement. Meanwhile the RBA has been a more active seller of AUD in recent months as the AUD has risen. In June it sold AUD1.94bn, the largest monthly sale on record, taking the two-month total to AUD3.4bn; easily outstripping government requirements of AUD1.9bn (according to Bloomberg data). The RBA and RBNZ could ease monetary policy further if the economies suffered a further downturn rather than look to FX. But the notion of verbal resistance (CAD, NZD) to currency rises and/or reserve management (AUD) to take advantage of currency shifts is another argument against the USD breaking lower. So the debate on the USD and G10 is still finely balanced and worth noting is last week's CFTC positioning data shows that USD net short positions grew to their largest level in twelve months, reaching 133.8K. * Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Capital team of economists is available here.