Opinion: Week of carnage

By BNZ Currency Strategist Danica Hampton It's been a week of carnage for the NZD. The local currency has fallen nearly 10% against the USD this week, from around 0.5900 on Monday to below 0.5300 last night. Sentiment towards the NZD has really turned this week. Tuesday's QSBO showed that business sentiment has fallen to levels not seen since 1970 and Standard & Poor's downgraded the outlook for NZ's foreign currency debt. Yesterday, Prime Minister John Key warned the NZ economy would come to a stand still in 2009 and the unemployment rate would rise to around 7.0-7.5% over coming years. A variety of accounts have been active sellers of NZD over the past few days, including short-term speculative players and real-money accounts. Strong interest to sell NZD against AUD has also been noted and two global investment banks put out "sell" recommendations on this currency pair yesterday. So far this week, NZD/AUD has fallen about 5%, from above 0.8500 to around 0.8050, which has added to the downside helped keep downward pressure on NZD/USD. Overnight, the USD strengthened against most major currencies as investors digested continued weakness in global equities and the ECB's 50bps rate cut. While the ECB's 50bps cut to 2.00% was bang on expectations, comments made by President Trichet in the press conference conveyed a seeming reluctance to cut rates further in February. Currency markets viewed this as bad news for the Eurozone economy and EUR/USD ended up falling from above 1.3200 to around 1.3050. Looking ahead, the combination of concern about the global outlook and the deteriorating local backdrop should ensure bounces in NZD/USD are limited. For today, we suspect the topside will be limited to 0.54200-0.5450. Initial support is seen around the 0.5290-0.5300, but a re-test of November's sub-0.5200 low is looking increasingly likely in coming sessions. The USD strengthened against most of the major currencies last night, as investors digested the ECB's rate cut decision and global equities remained soft. The ECB cut interest rates by 50bps to 2.00% last night "“ the lowest level since 2005. Denmark followed the ECB's lead and cut rates 75bps to 3.0%. In the accompanying press conference, ECB President Trichet said the risks to growth were to the downside but described the risks to price stability as "broadly balanced". Trichet also noted he was "very keen" to avoid a liquidity trapping, hinting that ECB was not thinking about moving to zero interest rate policy and/or quantitative easing. Overall, it looks like Trichet is signalling that the ECB will keep rates steady in February and re-assess the situation again in March. While the 50bps rate cut was bang on expectations, currency traders viewed Trichet's seeming reluctance to cut rates again in February as bad news for the Eurozone economy. In fact, the IMF said the Eurozone recession was "expected to deepen, before making a slow recovery later in 2009". As a result, while EUR/USD initially surged to around 1.3240, it didn't take long for the currency to slip back below 1.3050. Global equity markets fell again last night, as financial stocks were hit hard. The Wall Street Journal said Bank of America may need additional support from the US Treasury to help with its acquisition of Merrill Lynch. And Moody's downgraded the ratings on JP Morgan's senior debt (from Aa2 to Aa3) despite Q4 earnings coming in slightly above expectations. The Nikkei fell 5%, the FTSE slipped 1.4% and the DAX dropped 1.9%. US equities managed to erase some earlier losses as the US Democrats unveiled an US%825b stimulus bill. The S&P500 is currently down 0.5%. Weakness in global equities continues to provide safe-haven demand for USD. Last night's US economic news wasn't quite as bad as expected. The Philadelphia Fed index only fell to -24.3, better that the -35.0 forecast. The Empire manufacturing index only slipped to -22.2, above forecasts for a drop to -25.0. Against a generally firmer USD, USD/JPY climbed from below 88.50 to nearly 89.80 last night. The recent economic news out of Japan has also been pretty dire. Not only did yesterday's release show that machine orders dropped 27.7%y/y in November, but the Jiji Press is reporting that the BoJ may project negative growth for Japan in FY2009 in next week's BoJ mid-term economic outlook. * Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Markets team of economists is available here.