Opinion: Kiwi hit 58.5 USc overnight, but looks too high relative to economic fundamentals

By Danica Hampton The NZD/USD climbed to a three week high of above 0.5850 last night. Much of the recent NZD/USD strength is attributable to improving global sentiment. Investors have become hopeful the global economy is on the road to recovery and we've seen a strong rebound in global equities. As risk appetite improved, growth sensitive currencies like NZD have tended to strengthen, particularly against "˜safe-haven' currencies like the USD and JPY. However, the moves seen in currency markets over the past few days have tended to be exacerbated by model and technical-driven funds. For instance, in NZD/USD, the break above last week's high of 0.5775-0.5780 triggered a stop-loss run and solid demand from momentum-driven funds helped push the NZD/USD up above 0.5850. However, from a fundamental perspective, the recent gains in NZD/USD look unsustainable. Certainly, we've seen some glimmers of hope on the global front and this is helping NZ commodity prices. Yesterday's ANZ commodity index showed that the price of NZ's export bundle rose 2.5% in global terms during April. However, the rebound in the currency has more than offset any benefit from higher commodity prices, in NZD terms the index fell 2.8%. Nor should we forget we've seen a dramatic slide in NZ interest rates over the past month (thanks to growing conviction that the OCR will stay low for sometime to come and reduced demand for fixed rate hedging from domestic mortgage books). NZ-US 3-year swap rates have narrowed about 50bps over the past month to around 2.00%. The "˜fair value' range for NZD/USD (according to our short-term valuation model) is currently 0.5400-0.5600. This is significantly below the 0.5700-0.5900 range seen a month ago, as the narrowing of NZ-US interest rate spreads has more than offset the rebound in NZ commodity prices and risk appetite. This suggests there isn't a compelling fundamental reason to chase the NZD/USD significantly higher from here. While the NZD/USD looks too high relative to economic fundamentals, the near-term direction will depend on how global sentiment unfolds. For today, against a backdrop of heavy US equities we suspect bounces will be limited to 0.5880-0.5890. Initial support is seen around the 0.5700-0.5720 region. It was a choppy night in currency markets. The first half of the night was characterised by sharp USD weakness, but the USD recovered through the second half of the night as equities slipped and optimism about the global outlook faded. Hopes the global economy is on the road to recovery and reduced "˜safe haven' demand has tended to result in a weaker USD over recent days. Early last night, this optimism was supported by a stronger than expected UK construction PMI (it rose to 38.1 in April vs. 31.9 forecast) and strong gains in the FTSE. Solid demand for EUR and GBP from model and technical driven funds exacerbated the USD weakness. GBP/USD surged from below 1.5000 to above 1.5150 and EUR/USD climbed from below 1.3350 to nearly 1.3440. However, the USD weakness didn't persist. Downbeat comments from Fed Chairman Bernanke and a slide in US equities tempered the global optimism. Fed Chairman Bernanke acknowledged that the pieces where in place for the US economy to start to recover later in the year. However, he warned that even when the recovery does take hold, it is likely to be tepid and that unemployment may not peak until 2010. Bernanke's downbeat comments and nervousness ahead of the US bank stress results sent US equities lower. An unnamed source told Reuters than 10 of the 19 largest US banks being stress tested will be forced to raise more capital by US regulators, should the recession prove deeper and longer than anticipated. The S&P500 is currently down 0.75%. Nervousness ahead of the ECB meeting and downward revisions to the outlook for the Eurozone also took a toll on EUR/USD, which slipped back toward 1.3320. The EU Commission is forecasting a 4.0% contraction in GDP in 2009 and looks for a further fall of 0.1% in 2010. The downward revisions serve as a reminder that the Eurozone remains exceptionally weak, and the over-valuation of the EUR remains a significant drag on growth in the region. The big event for the EUR this week will be Thursday's ECB decision, where Trichet is expected to cut rates 25bps to 1.00% and formerly lay out non-conventional easing measures. While the ECB will likely extend the maturity of its liquidity measures and announce its prepare to buy corporate paper, it is unlikely to start buying government debt at this stage. ____________ * Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Markets team of economists is available here.