Domestic economic support for NZ dollar wanes

By Mike Jones

The NZD/USD spent most of last week in consolidation mode.

The currency was torn between support from a sliding USD on one hand, and the negative impetus from flagging momentum in the local economy on the other. In the end, the weaker USD won out and the NZD/USD finished the week 1% higher around 0.7330.

For a market already nervous about a ‘double-dip’ recession in the US, Friday night’s US non-farm payrolls data was like a red rag to a bull.

The headline 131,000 drop in employment was over double analyst expectations, sending US bond yields tumbling. A broad-based slide in the USD in the wake of the release eventually propelled NZD/USD above 0.7330.

For this week, Friday’s Q2 retail sales figures will probably mark the highlight of the local data calendar. The consensus is expecting another mild batch, but the real question is whether spending builds momentum in Q3, especially with the GST hike and personal tax cuts coming into view for 1 October.

Whatever the retail result, it is clear support for the NZD from the domestic economy has begun to wane. Last week’s jump in the unemployment rate (to 6.8% in Q2, from 6.0%) and a 4th consecutive monthly decline in dairy prices (for a cumulative decline of over 24% since April) were both cases in point.

As a result, on a trade-weighted basis at least, we suspect to see the NZD begin to move lower this week.

However, the NZD/USD is a different story. The simple fact is that USD weakness is the dominant driver of currency markets at present, a trend which is tending to float all boats. It’s hard to envisage a recovery in the USD this week given market chatter is abuzz with rumours the Fed could announce quantitative easing mark II at its policy meeting on Wednesday morning (NZT).

As such, we’re not convinced the NZD/USD is ready to roll over just yet. A test of resistance towards 0.7360 looks likely. Strong support is eyed on dips towards 0.7200.

Majors

News the US labour market remains weak saw the USD continue to slide on Friday. The USD index fell 0.5%, to be down over 9% since the June peak. Friday’s US non-farm payrolls report did nothing to allay fears the US recovery is running out of steam. Not only was the number of jobs lost in July greater than expected (-131,000 vs. -65,000), but there was also a hefty downward revision to June job losses as well.

A modest gain in private payrolls (71,000 vs. expectations of 90,000) was completely swamped by more census layoffs and massive job cuts by state and local governments. US government bond yields dived in the wake of the softer data, dragging the USD lower in sync. 2-year yields briefly slipped below 0.5% for the first time on record, while 10-year yields slumped 10bps to 2.81% – a 17-month low.

USD/JPY plunged to nearly 85.00 amid further contraction in US-JP interest rate differentials. At, 36bps, US-JP 2-year bond spreads are now down almost 65bps from April’s 100bps high. Meantime, both EUR and GBP shrugged off the impact of weaker than expected data to post fresh 3 and 6 month highs respectively against the flailing USD. German industrial production recorded a surprise 0.6%m/m fall in June (+0.5% expected) and June manufacturing production expanded a below-expectations 0.3% in the UK.

In fact, the only major currency not to post gains against the USD on Friday was the CAD. Indeed, USD/CAD climbed over 1% to nearly 1.030 after July employment figures revealed 9,300 jobs were lost during the month, in contrast to expectations for a 12,500 gain.

Looking ahead, all eyes will be on the FOMC policy meeting this week. Against a steadily deteriorating US economic backdrop (with Friday’s employment data the most recent example), speculation has grown the Fed will dust off its printing presses and initiate a ‘lite’ version of quantitative easing – in essence, reinvesting proceeds from maturing bonds back into the bond market, rather than letting its bond holdings gradually taper off.

The outcome of Tuesday’s Bank of Japan policy meeting is not expected to be quite as exciting, but the BoJ’s language will no doubt be scrutinised for any sign action is imminent to stem the JPY’s recent rise. All up, we suspect the USD will remain under pressure ahead of Wednesday morning’s (NZT) FOMC meeting, as reduced yield support and expectations of additional Fed stimulus measures take their toll. Near-term support on the USD index is eyed towards 80.10 with resistance at 81.00.

* Mike Jones is part of the BNZ research team. 

All its research is available here.