Opinion: Kiwi overstretched, but unlikely to weaken until sentiment falters

By Danica Hampton Fluctuations in risk appetite saw NZD/USD tossed about within a 0.6000-0.6100 range last night. Early in the night, it was all about the glass being "half full". ECB President Trichet said the world was at an "inflection point" and could start recovering soon. Better than expected UK data (manufacturing, trade balance and jobless claims) helped the general feeling of well-being. In currency markets, trimming back of "˜safe-haven' positions saw the USD weaken broadly and dip buying from short-term speculative accounts saw NZD/USD push up to nearly 0.6100. However, all it took was a slide in US equities and suddenly investors thought the glass looked "half empty" again. The pick-up in risk aversion triggered heavy selling of JPY crosses and NZD/JPY skidded from above 59.00 to below 58.00. The firmer USD tone was also probably helped by a narrower than expected US trade deficit (it fell to US$27.6b vs. US$29b forecast). As a growth sensitive currency, the near-term fortunes of the NZD/USD will depend greatly on how global sentiment unfolds. While some "green shoots" are evident in the global economy, we think equity markets and investors have become overly optimistic about the timing and strength of the global recovery. We are sceptical about equity markets' ability to hold on to recent gains in the face of higher global bond yields and think a reality check is past due. Fundamentally, we think NZD/USD looks over-stretched above 0.6000, but we're unlikely to see the currency weaken significantly until global sentiment starts to falter. For today, we suspect NZD/USD will find headwinds towards 0.6080. Initial support is seen around 0.5990-0.6000. Keep an eye out for Japan's current account (11:50am) and China's retail sales and industrial production data (2:00pm today) any hint of weakness will likely take a toll on global sentiment, risk appetite and growth sensitive currencies like the NZD. Locally, the RBNZ's Financial Stability Report is due at 9:00am. The USD finished the night pretty much unchanged against the major currencies, but it was an extremely choppy night as currencies will pulled and pushed by the changes in global sentiment. Through the first half of the night, risk appetite returned and the USD weakened as investors trimmed "˜safe-haven' positions. ECB President Trichet said the global economy was at an "inflection point" and could turn the corner soon. The optimism was also helped along by relatively upbeat UK data (manufacturing output fell just 0.1% in March the slowest rate in 13 months, while the surprisingly small drop in the claimant count seemed at odds with the rise in the unemployment rate). Against a generally weaker USD, EUR/USD rose from below 1.3600 to a 7-week high of 1.3706. Comments from the ECB's Weber, who said there was no need to the ECB to expand its asset purchase program into other sorts of debt, also probably helped the firmer EUR tone. But the USD weakness didn't last. Risk appetite and global sentiment deteriorated through the second half of the night as US equity markets skidded. Shares in General Motors fell 22% after it was revealed that 6 top executives have liquidated their shares in the company. General Motors has a government-imposed deadline of June 1 to either restructure the company for file for bankruptcy. At one point, the S&P500 was down over 1%, although it's now erased much of its earlier losses. The slide in US equity markets tempered risk appetite and this triggered heavy selling of JPY crosses. EUR/JPY dived from above 133.50 to below 131.00, which dragged EUR/USD back down towards 1.3600. In conjunction with renewed "˜safe-haven' demand, the narrower than expected US trade deficit for May (-US$27.6b vs. -29.0b forecast) probably also helped USD sentiment. Despite a firmer USD tone, widespread selling of JPY crosses saw USD/JPY sink from around 97.80 to under 96.50. Yesterday's Chinese and Indian data served as a reminder that much of the world remains in recession. Chinese exports fell 22.6%y/y in April (vs. -15.3% forecast) and imports fell 23%y/y (vs. -22% forecast). Industrial production in India dropped 2.3%y/y in March, well below the expected drop of 0.7%. While recent data suggests the global economy is contracting at a slower pace, it's by no means heralded at actual turnaround. Nor are there any signs that once global expansion actually starts that it will sustained, let alone rapid. ____________ * Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Markets team of economists is available here.