Opinion: NZ$ starts Budget week softly on euro doubts

By Mike Jones The NZD/USD spent most of last week in a downward trajectory. Having started the week around 0.7300, NZD/USD slipped below 0.7100 on Friday. Still, on a trade-weighted basis, the NZD was more or less unchanged over the week. Initial optimism about the EU-IMF’s emergency aid package faded over the second half of last week. Not only did policy makers caution the deal is only a temporary fix, but investors worried harsh fiscal austerity measures will stymie the tentative economic recovery underway in Europe. Global stocks surrendered some of the week’s early gains and risk aversion marched higher. As a result, ‘safe-haven’ currencies like the USD and JPY returned to favour, and investors trimmed positions in ‘growth-sensitive’ currencies like the NZD and AUD. Nevertheless, with the contrasting economic fundamentals between NZ and Europe increasingly obvious, both NZD/EUR and NZD/GBP surged to new highs, helping to limit last week’s overall NZD losses. The budget looms large as the key NZD event risk this week. We expect Thursday’s edition to not look so bad, in respect to lessening deficits, from recent levels of around 4-5% of GDP, and a slower uplift in (net) debt from moderate beginnings. The latter should afford a mild reduction in the bond programme (in which, watch for any announcements about index-linked bonds). While the Budget has potential to be mildly NZD/USD positive, we suspect developments in European sovereign debt markets will remain the bigger driver of the currency for now. Further slippage in equities and risk appetite could see NZD/USD test support towards 0.6970. Nevertheless, positive NZD fundamentals, such as accelerating NZ growth, surging commodity prices, and widening interest rate spreads, should keep the NZD cross rates well supported over the week. Most notably, NZD/EUR looks set to push higher still, as concerns over anaemic European growth continue to weigh on EUR/USD. Majors The USD and the JPY were the strongest performing currencies on Friday night as renewed investor nervousness spurred demand for “safe-haven” assets. Fears over the health of the Eurozone once again dominated sentiment on Friday. For the most part, investors are worried tough austerity measures will provide severe headwinds for economic growth in the region. But a speech from ECB policy maker Weber also highlighted the “dangers to financial stability that still exist”. And reports French President Sarkozky had threatened to pull France out of the Eurozone did nothing to allay fears the Eurozone could break up. Reflecting these developments, European equities slumped and risk appetite dried up. The VIX index (a proxy for risk aversion) surged from 26% to almost 33% on Friday. Of note, Spanish stocks plunged 6.6% as a surprise drop in inflation spurred deflation fears. US markets were certainly not immune from the pessimistic mood. US stocks dipped 1.5-2.0% and the CRB index (a broad index of global commodity prices) fell 2.7%. With all of markets’ focus in Europe, confirmation the US recovery is continuing did little to sure up sentiment. US retail sales and industrial production data for April both managed to outstrip analyst expectations slightly. Sliding global equities and rising risk aversion saw ‘growth-sensitive’ currencies sold in favour of the relative ‘safe-haven’ of the USD and JPY. JPY crosses were marked lower across the board and USD/JPY fell as low as 91.80. Not surprisingly, concerns about growth in the euro region took a heavy toll on EUR. EUR/USD tumbled to fresh 18-month lows of nearly 1.2360, to be down just over 3% for the week. Looking ahead, we wouldn’t be surprised to see EUR/USD fall further this week. For 2010, analysts forecast growth of only 1.2% in the Eurozone on an annual average basis. This compares to the 3.2% expected in the US. To us, this suggests EUR/USD should be trading below, or at least closer to, it’s long-run “fair-value”, which we estimate at around 1.2100. We suspect developments with respect to the European sovereign debt crisis will again provide the key direction for equity markets and currencies this week. But there is still some event risk to watch out for. The German ZEW and IFO surveys will give some idea as to whether recent market disruptions have weighed on business confidence. UK retail sales, April US housing data and Eurozone CPI will also be worth watching. Lastly, keep an eye out for the minutes from recent FOMC, BoE, and RBA meetings. *All of the research produced by the BNZ Capital team of economists is available here