Opinion: Kiwi could fall to 53 USc if swap spreads narrow further

By Danica Hampton Across the board currencies are mildly firmer as risk appetite recovers, once again market sentiment showing itself to be fluid and easily diverted by media and data releases. As our analysts wrote earlier in the week, implied 'fair value' for the NZD/USD (according to our short-term valuation model) had fallen over the past week; from above 0.5700-0.5900 to around 0.5550-0.5750 and despite the overshoot to the downside we open this morning close to the middle of the "˜fair value' range. The drop last week in 'fair value' had been driven by the narrowing of NZ-US 3-year swap spreads, which fell from 2.61% to 2.33% over the previous week. That compression in NZ-US interest rate spreads, in part driven by the OECD report, had more than countered a rebound in NZ commodity prices. It has been a dramatic start to the week for the NZD/USD, the rush to the 0.5500 level eventually drawing out a healthy mix of offshore investor demand as well as onshore commercial and institutional buyers at what is for now the lower end of this week's range. These flows providing some succour when offshore influences and momentum had weighed on major currency sentiment. Yesterday's migration data was largely as one would expect. Seasonally adjusted net immigration was 1,720 in March. This suggested February's +1,600 was no one-off. The net gains have mainly reflected lessening migrant outflows (Kiwis staying at home) but there has also been something of annual increase in inflows as well. While the immigration story is becoming more positive, the tales around tourism are becoming more negative. The underlying trends in tourist arrivals are negative, and will probably get worse this year before any recovery. Locally the calendar remains light; NZ is back under the spotlight next week with the NBBO and of course the RBNZ OCR. Bearing in mind our "˜fair value' analysis then any challenge of the 0.5700/0.5750 level is likely to meet strong resistance while the improved sentiment should help the NZD hold above the 0.5550/0.5600 level at the moment. We still think the market is underestimating the scope for further monetary policy easing. We continue to look for an eventual trough in the OCR of 2.00% and as the market comes into line with our view, we'd expect the downward pressure on NZ interest rates to also weigh on NZD/USD. For example, if NZ-US 3-year swaps rates narrow back to 2.00% this would see the implied 'fair value' of our short-term valuation model fall to 0.5300-0.5500. There is a mix of data and media influences that have helped calm markets and help risk FX recover and major equity markets print close to positive territory. Firstly the ZEW economic sentiment index surprised on the upside, rising from -3.5 to +13.0. That outcome compared with consensus expectations for an increase to +2, although the range of economist forecasts ran between -5 and +17. However, we believe that it is far too early to start calling a recovery in Germany as Press reports suggest that the German government is preparing to revise down its forecasts of 2009 GDP growth to -5. Both the BoC and Riksbank halved their cash rates, to 0.25% and 0.5% respectively. Both are in the process of preparing for QE and suggested current monetary settings will remain low well into 2010. US equity markets and hence risk appetite took heart from Treasury Secretary Geithner commenting that the vast majority of the nations banks have enough capital, helping to allay yesterdays fears about the My 4 release of stress test results. The comments also helped on a day when a number of US banking names reported for Q1 "“ and most of these under whelmed their stock holders. On the data front, Aust Q1 CPI is released today and our Australian analysts forecast a 0.3% rise in headline inflation and 0.8% for the underlying measures. This would keep the underlying measure running close to 4% in YOY terms but it is expected that contracting economic activity in 2009 will bring about an easing in core price pressures. The RBA minutes yesterday concurred with this sentiment, their April easing deemed appropriate when they considered data releases of the previous month and tempered their previous outlook from March. _________ * Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Markets team of economists is available here.