Opinion: Nerves grow about a rescue package deadlock

By BNZ Currency Strategist Danica Hampton The NZD/USD slipped lower last night, pressured by a generally stronger USD and risk aversion-inspired selling of NZD/JPY. The USD erased much of yesterday losses last night following the sharp correction in crude oil prices. After climbing to nearly US$130/barrel yesterday, crude oil prices slipped below US$105/barrel last night. Against this backdrop, EUR/USD skidded from above 1.4800 to below 1.4650 and NZD/USD was dragged down from above 0.6900 to below 0.6800. Meantime, Fed Chairman Bernanke and Treasury Secretary Paulson received a roasting from the Banking Senate Committee regarding the details of the US Treasury bailout package. While Bernanke warned that failing to approve the bailout package raises the risk of a US recession, senators appear far from convinced it's the best course of action. A slide in US equities and rising risk aversion encouraged selling of growth sensitive currencies like NZD against "˜safe-haven' currencies like JPY. NZD/JPY slipped from above 73.00 to below 72.00 and this added to the downward pressure on NZD/USD. Today's Westpac McDermott Miller consumer confidence will likely show some recovery "“ similar to recent Roy Morgan and Colmar-Brunton polls. However, we suspect the improvement in household sentiment will prove to be transitory. We are inclined to view last night's USD rebound as a correction from yesterday's excessive selling. Nonetheless, against a backdrop of slowing global growth and fragile risk appetite, we suspect bounces in the NZD/USD will be limited to the 0.6860-0.6870 region. Initial support is seen around 0.6780 and a break below this level will open up the downside towards 0.6700. The USD climbed against most of the major currencies last night. While the USD is still far from out of the woods (as concern about how the US Treasury will fund its bail-out package still lingers), a dramatic correction in crude oil prices saw the USD reverse much of yesterday's heavy losses. Crude oil prices (as measured by the first Nymex futures contract) surged as high as US$130/barrel yesterday, but fell 4.5% to below US$105/barrel last night. Much of the recent volatility in crude oil prices is being attributed to the forced unwind of positions at yesterday's October futures close out. Over the past year, crude oil prices have tended to have a negative correlation with the USD (as investors speculate that rising fuel prices act as a handbrake on US consumer spending). After climbing above 1.4800, heavy selling saw EUR/USD slide below 1.4650. Data suggesting that activity in the Eurozone is slowing did little to help EUR sentiment. In September, the Eurozone manufacturing PMI fell sharply to 45.3 "“ the lowest reading since December 2001 "“ and the service sector PMI fell to 48.2. The data increases the chances of Eurozone GDP contracting again in Q3 "“ resulting in a technical recession. Some selling of EUR/JPY was also noted during a patch of weakness in US equities and this added to the weight on EUR/USD. US stock markets traded choppily last night reacting to comments from Fed Chairman Bernanke and US Treasury Secretary Paulson as they explained the details of the proposed bailout package to the Senate Banking Committee. US stocks skidded after Bernanke bluntly warned Congress it risks a US recession if it fails to pass the US$700b bailout package. Nonetheless, while the senators said they were prepared to take action, they appeared far from ready to give Paulson everything he wanted. However, US stocks rebounded off the lows following reports that the SEC was starting to enforce its short selling restriction. While the bailout plan will likely stave off a breakdown of the financial system (if approved), it is unlikely to materially bolster the US economy or prevent a recession in the Eurozone and the UK. Against a backdrop of slowing global growth and rising risk aversion, we'd expect safe-haven currencies like JPY to out perform growth sensitive currencies. While the financing of the bailout package raises some questions about the US fiscal deficit, we suspect the USD will also remain well supported against a backdrop of slowing global growth. * Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Markets team of economists is available here.