Opinion: Kiwi$ back in the dog-box

By Danica Hampton It was a dramatic start to the week for the NZD/USD, which has fallen from above 0.5700 to below 0.5500 as risk aversion sky-rocketed. Heavy losses in financial stocks saw global equities plunge. Bank of America reported a surprisingly large increase in troubled loans, JP Morgan warned there may be another US$400b worth of write-downs yet to come and there is general nervousness about the results of the US Treasury's bank stress testing. The FTSE fell 2.5%, the DAX dropped 4% and the S&P500 is currently down 4.3%. As global equities plunged all the rose tinted glasses and "half-full" champagne flutes were all crushed underfoot as investors ditched growth sensitive currencies like NZD in favour of the relative safety of USD and JPY. NZD/JPY skidded from above 56.00 to below 54.00 and NZD/USD was dragged below 0.5500 "“ its lowest level in about a month. While last night's NZD action was largely about risk aversion, it's worth noting that the downward pressure seen on NZ interest rates over recent weeks also adds to the case for a weaker NZD/USD. Looking ahead, we continue to see downside risks to both NZ interest rates and the NZD. 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% (which is more dovish than current market pricing). 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 swap spreads narrow back to 2.00% this would see the implied 'fair value' of our short-term valuation model fall to 0.5300-0.5500 (everything else held constant). For today, the deteriorating global backdrop should ensure bounces in NZD/USD are limited to the 0.5580-0.5600 region. Initial support is seen around 0.5470, but the risks remain to the downside and a deeper pull-back towards 0.5400 looking likely in coming sessions. The USD strengthened against all the major currencies last night, as global equities skidded and risk aversion sky-rocketed Heavy losses in financial stocks saw global equities plunge overnight. Bank of America reported earnings per share of 17 cents (well above analyst estimates of 4 cents), but this was overshadowed by a surge in its troubled loans. JP Morgan estimated that banks could incur US$400b more in write-down losses and that certain institutions will need more capital. Bank of America shares fell more than 20% and the S&P500 financial index is currently down 11.5%. Nervousness ahead of US banking stress tests results may also be contributing to the weaker tone (although most of the leaks in the media reports sound relatively constructive). Last night's US data was also uninspiring, the US leading indicator fell -0.3% in March (worse than the -0.2% forecast). The FTSE fell 2.5%, the DAX dropped 4% and the S&P500 is currently down 4.3%. The sharp decline in global equities zapped risk appetite and encouraged investors to flock to the relative safely of the USD. The DXY Index (a trade weighted USD bundle) has climbed about 1% in the past 24 hours and is now sitting at levels not seen since before the Fed's March meeting (where it stepped up its quantitative easing program). Sky-rocketing risk aversion also encouraged investors to sell JPY crosses. As well as the usual short-term speculative players, a range of investment managers (reportedly tax-related repatriation) have had a steady supply of JPY crosses. EUR/JPY dived from around 129.00 to below 126.50 and USD/JPY sank from 99.00 to nearly 97.50. Against a generally firmer USD and steady EUR/JPY supply, EUR/USD skidded from above 1.3000 to below 1.2900. Comments from ECB council member Nowotny, who said the central bank should look at what it can do beyond the policy rate to stimulate growth, added to the weight on EUR/USD. Looking ahead, we expect the USD will remain underpinned. Not only will safe-haven demand provide support, but we also suspect the USD will end up looking the best of a bad bunch in terms of forward looking economic prospects. Any sign of weakness is this week's European data should add to the downward pressure on EUR/USD and a pull-back towards 1.2800-1.2850 looks likely in coming sessions. * Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Markets team of economists is available here.