Opinion: Global equities melt down, can G7 help?

By BNZ Currency Strategist Danica Hampton The NZD/USD finished last week below 0.5900 as fears about a global recession and a melt-down in global equities swept across financial markets. The burgeoning global credit crisis sent stock markets into a tail-spin last week. The S&P5000 sank 18%, the FTSE fell 21%, the German DAX dived 22% and the MSCI World Equity Index finished down 20%. Meantime, our risk appetite index (which has a scale of 0-100%) sank to 15%, well below the long-term average of 50% and its lowest level since February 2003. In currency markets, the panic sweeping across financial markets saw investors liquidate positions in growth sensitive currencies like AUD and NZD. Meantime, repatriation flows and "˜safe-haven' demand tended to underpin both USD and JPY. Since the start of October, the AUD has fallen 19%, NZD has fallen 11% and the EUR has fallen 5% against the USD. In contrast, the JPY has strengthened 5.5%. The G7 nations met over the weekend and the communiqué stressed the need for coordinated action to do whatever is necessary to stabilise financial markets, restore the flow of credit and support global economic growth. The G7 nations agreed to a five point plan: 1. Take decisive action and use all tools available to support systemically important financial institutions and prevent their failure. 2. Take all necessary steps to unfreeze credit and money markets and ensure that banks have access to liquidity and funding. 3. Ensure that major financial institutions have raised capital in sufficient amounts to re-establish confidence and permit them to continue lending to businesses and households. 4. Ensure national deposit insurance programs are robust enough to ensure confidence in the safety of bank deposits. 5. Take appropriate action to restart secondary markets for mortgages and securitised assets. While the IMF endorsed the G7 statement, it also said the world's financial system was near meltdown and warned that global equities could plunge by a further 20% in the coming days unless governments deliver concrete action to address the crisis. While the seemingly united front of the G7 is encouraging, we expect markets will be disappointed by the lack of detail in the G7 communiqué. The communiqué stopped short of backing the UK proposal of guaranteeing inter bank lending and didn't offer any concrete plans on how authorities will go about shoring up confidence in the banking sector. While the G7 communiqué itself was light on detail, several countries have unveiled their rescue plans over the weekend.

• In the US, the Bush Administration has shifted the focus of its rescue plan from buying distressed assets to directly injecting capital into banks. Treasury Secretary Paulson has said the first capital injection may be implemented within the next two weeks.

• Eurozone leaders are working on a collaborative European rescue plan. French Finance Minister Lagarde has said "you will not be disappointed and it will be quite specific". German Chancellor Merkel said the Eurozone will implement "the same toolbox of instruments". Media reports suggest a German rescue package could be worth up to EUR400b, including direct capital injections into banks and possibly guarantees for inter bank lending.

• In Australia, the government has not only guaranteed all bank deposits for three years, but has guaranteed all term wholesale funding by Australian banks operating in international markets and has injected A$4b into residential-backed securities to help shore up the Australian mortgage market. These measures should ease householders concerns about the safety of their bank deposits and alleviate some of the funding difficulties faced by Australian banks.

• In NZ, the RBNZ and the Treasury announced a scheme to guarantee retail deposits held at registered banks and non-bank deposit-taking financial institutions.

At this point it is difficult to say when confidence to return to financial markets, but we suspect we'll need to see concrete evidence that the rescue efforts taken by the G7 countries are actually working (i.e. the cost of inter banking lending starts to fall, banks are recapitalised and credit markets show signs of functioning again) to restore investor confidence in the financial sector globally. Meantime, expect currency markets to continue taking their intra-day cues from equity markets. For NZD/USD, a floor seems to have been found below 0.5800, at least for now. A variety of local exporters and real-money accounts have shown appetite for NZD/USD on dips and solid support is seen ahead of last week's low of 0.5785. On the topside, some headwinds are expected around the 0.6240-0.6250 region near-term, but the NZD/USD has the potential to push back towards 0.6400-0.6450 should we see substantial improvement in risk appetite and equity market confidence. * Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Markets team of economists is available here.