Opinion: What the Lehman turmoil might mean for the NZ$

By BNZ Currency Strategist Danica Hampton The NZD/USD climbed higher on Friday night, from below 0.6550 up to nearly 0.6700. Soft US retail sales (which fell 0.3%m/m in August vs. 0.2% forecast) and heavy USD selling at the London fix underpinned NZD/USD. The break above 0.6600 triggered a bout of stop-loss buying and NZD/USD was propelled up towards 0.6690. Over the weekend, the US authorities were unable to find a saviour for Lehmans and the troubled US investment bank looks like it's headed for liquidation. Growing worries about the health of the US financial sector will likely spur speculation about near-term Fed rate cuts (particularly ahead of this week's FOMC meeting), which will likely weigh on USD and provide some support for NZD/USD. However, escalating risk aversion and concern that the problems in the US financial sector will spill across into global issues are likely to take 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 the potential to keep NZD/USD range bound this week. Overall, we 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. Locally, from a data perspective, Monday's service sector activity indicator has tracked that of its manufacturing counterpart in recent months and, as such, a fall could be on the cards - with such providing one more hint that talk of the economy finding its feet might be a little premature. It will also be worth keeping an eye on Q2 manufacturing activity and the current account deficit for clues on how Q2 GDP is shaping up (our preliminary forecasts have GDP falling 0.3%q/q). Majors The much anticipated recovery in the major currencies arrived on Friday night. EUR/USD surged from around 1.4050 to above 1.4150 after disappointing US data. Retail sales fell -0.3%m/m in August (vs. forecasts of 0.2%), excluding automobiles sales dropped 0.7%m/m (vs. -0.2% forecast). An article in the Financial Times, suggesting Bank of America was leading a syndicate to buy Lehmans, helped risk appetite and demand for JPY crosses. Solid demand for EUR/JPY pushed EUR/USD up above 1.4200. Despite a weekend of emergency meetings, the US authorities were unable to find a saviour for Lehmans and the US investment bank looks like it's headed for liquidation. Over the weekend, Barclays emerged as the leading contender to buy all or part of Lehmans. But with US federal officials adamant that no public money be used, Barclay's walked away from the deal late on Sunday making liquidation more likely. The liquidation of Lehmans would likely pressure other securities firms, insurance companies and banks, notably Merrill Lynch and the American International Group, both of which have come under mounting pressure in the markets over the past few days. Indeed, such an event would likely result in intense speculation about near-term rate cuts from the Fed. As market participants digested the Lehmans news, the knee-jerk reaction was to sell USD, but escalating risk aversion has also resulted in selling JPY crosses. After closing in NY around 108.00, USD/JPY has fallen to nearly 105.80 this morning. EUR/USD initially spiked from its NY close of 1.4225 to 1.4330, but selling of EUR/JPY (the cross has slipped from nearly 153.50 to below 151.50) knocked EUR/USD back towards 1.4250. Growing speculation about near-term Fed rate cuts should weigh on short-dated US interest rates and see the US yield curve steepen (curve steepening will also help banks recapitalise). 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 EUR/JPY. Either way this will result in further USD/JPY weakness. First support is 105.50 the September 5 low, but a test of July's lows of 103.77 looks likely. We suspect risk sensitive currencies will also fare badly. 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 struggling 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.