Opinion: NZ$ weak as default risk on NZ sovereign debt rises

By Danica Hampton NZD/USD has spent the past 24 hours consolidating within a 0.5050-0.5150 range. Overnight, the USD continued to strengthen as concerns about the Eurozone, UK and Japan took centre stage. ECB executive board member Lorenzo Bini Smaghi told us "we are facing the most serious economic crisis since World War II", which combined with lingering worries about Eastern European economies weighed on EUR/USD. In the UK, the Bank of England minutes made it clear the central bank is close to adopting measures like quantitative easing and the Financial Times warned the UK was a risk of losing its triple-A rating. Meantime, the JPY is being weighed down by fears the sudden resignation of the Finance Minster will delay fiscal spending plans. NZ is well placed to weather the financial crisis - with a sound macro-economic framework and highly rated banks. However, it's interesting to note, credit default spreads on NZ sovereign debt have widened over recent days suggesting NZ is not immune to the default fears currently plaguing the global economy.

While risk aversion and a generally firmer USD is weighing on NZD/USD, profit-taking on "short NZD" positions has provided some support on dips towards 0.5060. Some demand for NZD against the crosses (particularly AUD and EUR) has also provided a bit of support for NZD/USD. The NZD/USD is currently sitting within the 0.5050-0.5250 "fair value" range implied by our short-term valuation model. This suggest unless you expect to see further narrowing of NZ-US interest rate spreads, a heavy slide in risk appetite or further losses in NZ commodity prices there isn't a compelling reason to chase the currency lower in the near-term. For today, the deteriorating global backdrop and the generally firmer USD, should limit the topside in NZD/USD. We suspect bounces in NZD/USD will be limited to 0.5150. Solid support is expected around the 0.5000-0.5020 region. The USD firmed against the major currencies last night as worries about Europe and the UK weighed on investor sentiment. EUR/USD traded within a 1.2500-1.2650 range last night. Concern about the financial stability of Eastern European economies continues to take a toll on EUR sentiment. ECB Smaghi said "we are facing the most serious economic crisis since World War II". While Smaghi acknowledged that considerable challenges lay ahead for the EUR, he is confident the currency is up to the challenge. GBP/USD spent the night in a 1.4100-1.4300 range. The Bank of England minutes made it clear that further rate cuts were by no means certain and that the central bank will likely focus on other measures such as quantitative easing in order to help stimulate lending. A UK Times article suggesting the UK was at risk of losing its Standard & Poor's AAA rating and a very soft CBI industrial trend survey (the headline series dropped to -56 the weakest reading since January 1992) did little to aid GBP sentiment. Meantime, the JPY seems to be losing its status as a "safe-haven" currency. Since the start of the week, USD/JPY has climbed from around 91.50 to nearly 94.00. A recent report showed that Japan's GDP contracted 3.3%q/q in Q4 - much worse than the -1.5%q/q seen in the Eurozone and the -1%q/q seen in the US. What's more, the sudden resignation of Finance Minister Nakagawa has raised fears that Japan won't be able to move fast on the fiscal front. Equity markets were weak across Asia, Europe and the US. While Obama's US$75b plan for stemming home foreclosures is encouraging, investors are still concerns about the troubles plaguing Eastern Europe and the auto industry. Little attention was given to the weak US data "“ industrial production -1.8% vs. -1.5% forecasts and housing starts fell 15% to 466,000. The FTSE fell 0.7%, the DAX dropped 0.3% and the S&P500 is currently down 0.6% Risk appetite and equity market performance will likely remain the key drivers of currencies near-term. While the new US stimulus package has the potential to inject some optimism into the markets, we suspect this will be overshadowed by fears about the financial sector and emerging economies. As such, defensive equity markets and muted risk appetite should ensure "safe-haven" demand continues to underpin the USD. * Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Markets team of economists is available here.