Opinion: Post Lehman risk aversion weighs on Kiwi$

By BNZ Currency Strategist Danica Hampton The NZD/USD faded from the US67 cent level in London trade, caught up in the maelstrom of traders and investors paring risk as the uncertainty surrounding a number of US financial institutions drove sentiment. We had seen this at times in trading yesterday, however the offshore session has been particularly nasty as the NZ$ tumbled sharply against a backdrop of European equity markets that across the board lost around 4% of value, (US markets closed down 4.4%). Over the weekend, the US authorities were unable to find a saviour for Lehman's and the 158 year old US investment bank on Monday filed for Chapter 11 at the U.S Bankruptcy Court in South New York. Growing worries about the health of the US financial sector spurred some speculation about near-term Fed rate cuts, ( ahead of this week's FOMC meeting), as the market absorbed the news that Merrill Lynch & Co. was acquired by Bank of America and AIG, the US's largest insurer was given permission to access $20b in reserve assets to free up liquidity. As expected, escalating risk aversion and concern that the problems in the US financial sector will spill across into global issues are taking a toll on risk sensitive currencies like NZD/JPY. The countervailing forces of a weaker USD and risk aversion inspired selling of NZD/JPY has for now kept the NZD/USD in a broad but somewhat familiar range at the start of our week. Overall, we continue to suspect any recovery towards 0.6750-0.6800 in NZD/USD will attract fresh sellers. Initial support is seen around the 0.6500 region and it will take a break below last week's 0.6440 low to suggest the downtrend is gaining traction. From a data perspective, yesterdays manufacturing statistics implied a slip in June quarter production. Nothing big, but enough for us to revise down, and finalise, our Q2 GDP estimate to -0.4%, from -0.3% (and, in looking at all of our Q2 GDP inputs, we would say the risks are inclined toward something more negative than -0.4% rather than less). Sure, excluding the meat and dairy category (where a drought-driven drop in dairy production/sales/exports dominated proceedings), real manufacturing sales expanded 1.8% in Q2. However, this relied heavily on a draw-down from stocks, meaning production in the quarter probably fell a moderate bit. Despite a weekend of emergency meetings, the US authorities were unable to find a saviour for Lehman's and the US investment bank headed for liquidation. Over the weekend, Barclays emerged as the leading contender to buy all or part of Lehman's. But with US federal officials adamant that no public money be used, Barclay's walked away from the deal late on Sunday making liquidation inevitable. The demise of Lehman's has pressured other securities firms, insurance companies and banks, notably Merrill Lynch and the American International Group. As events unfolded traders began to increasingly anticipate a near-term rate cut from the Fed. At the CBoT, futures' trading shows the chance of a cut tomorrow has surged to 86%. As market participants digested the Lehman's news, the knee-jerk reaction was to sell USD, but escalating risk aversion has also resulted in selling JPY crosses. After closing in NY on Friday around 108.00, USD/JPY has fallen to nearly 104.50 overnight. EUR/USD challenged but failed at the 1.4450 level, selling of EUR/JPY sending the EUR southwards to the 1.4100 level. Growing speculation about near-term Fed rate cuts has weighed on short-dated US interest rates and seen the US yield curve steepen. In currency markets, the question to ask is whether the negative US financial sector news will weigh more heavily on the USD or on risk sensitive currencies like the NZD, AUD and emerging market currencies. At the moment the latter is the markets first response, after all global financial markets are so interrelated, any problem in the US financial sector will likely become a global problem. Nor should we forget that troubled US banks may well be forced to repatriate offshore assets. * Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Markets team of economists is available here.