By BNZ Currency Strategist Danica Hampton
The week has started with risk appetite still hamstrung, almost non-existent as the NZD trades lower, albeit at a slow pace.
The NZD moves reflected across all major FX following the G7 met over the weekend and the communiqué which made it apparent there is no "quick fix" to the troubles ailing the global economy. In fact, despite the worldwide measures taken by central banks and governments, the G7 expects the "severe downturn" to persist "through most of 2009".
Yesterdays PSI reading for January moved clearly into contraction territory from December's 48.0, to a January result of 42.7.
This is the lowest value since the survey began in April 2007. Most regions exhibited contraction during January, an outcome Business NZ chief executive Phil O'Reilly said was unsurprising, but the level of the drop was severe. BNZ economists say the rapidly softening labour market was a concern and employment and capital expenditure would be the big things to watch.
The implied "fair value" level of NZD/USD (as determined by our short-term valuation model) has nudged a little lower over the past week, from last week's 0.5100-0.5300 to around 0.5050-0.5250.
The slide in 'fair value' was driven by a modest narrowing of NZ-US 3-year swap spreads (fallen 7bps to 1.62%) and a modest drop in risk appetite (our risk appetite index has dropped 2% from 18% - its still well below the long-term average of 50% signalling that investors are still risk averse).
With the NZD/USD currently sitting within its "fair value range, this suggests there isn't a compelling fundamental reason to chase the currency higher from here. Indeed, given the G7's gloomy global outlook and renewed concerns about the financial sector we suspect bounces in NZD/USD will be limited this week. However, 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 this also suggests dips below 0.5000 will be short-lived.
Risk appetite and equity market performance will likely remain the key driver of the NZD over the coming week. While the US House of Representatives passed the US$787b stimulus bill, the G7's gloomy global outlook and fresh concerns about the financial sector should keep equity markets defensive and risk appetite muted. As such, "˜safe-haven' demand should continue to underpin the USD and ensure bounces in NZD/USD are limited.
For the coming week, we suspect bounces in NZD/USD will be limited to 0.5300-0.5350. Initial support is seen ahead of 0.5150, but a break below this level would suggest a slide back towards 0.5000 is on the cards.
Safe-haven demand continues to underpin the performance of the USD against most major currencies amid ongoing concern about the financial sector and soft global equities.
Yesterday Japan recorded a massive 3.3%qoq slide in GDP for the December quarter of 2008, the largest fall since 1974. Japan is now running merchandise trade deficits for the first time in almost 30-years. When this last occurred in the late-1970s/early-1980s, the trade-weighted value of the JPY fell by almost 30%. The chart below shows the historical relationship between the JPY and the trade balance.
Looking ahead the RBA release the minutes from their February Board Meeting today, the main value in these will be to see how close the RBA came to a larger cut.
Tonight the German ZEW is the week's highlight of a slow few days for data. The market is looking for an improvement in the headline sentiment index, but our economists are more sanguine about this.
From the UK we have January CPI data, which should show a further decline in the annual rate as the VAT cut becomes embedded in the economy. There is some risk the lower GBP may negate this and already have fed through in some price components.
After enjoying Presidents Day and a long weekend, US markets return to face the Empire Mfg Survey (forecast at -23.75 from -22.2) as well as expectations for little change in both the NAHB Housing Market Index (previous; 8 ) and the ABC Consumer Confidence (previous; -53).
* Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Markets team of economists is available here.
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