Evidence of 'strong' Europe, US growth offsets risks to the global economy from Japan’s nuclear crisis, European debt concerns

By Mike Jones

It was pretty much one way traffic in the NZD last week. Having started the week around 0.7300, the NZD/USD climbed steadily to reach a 3½ week high of 0.7550 by Friday. In fact, the NZD was the strongest performing G10 currency over the week.

Global investors found new cause for optimism last week, despite the many risks to the global outlook. Indicative of such, the MSCI World Equity Index posted the largest weekly gain since December (of 3%) and our risk appetite index (which has a scale of 0-100%) rebounded 19 percentage points, to 68.7%. The less risk averse global backdrop saw investors ditch ‘safe-haven’ currencies like the USD and JPY and reduce the extent of ‘short’ positioning in ‘growth-sensitive’ currencies like the NZD and AUD.

On Friday, positive risk sentiment saw the AUD/USD soar to a fresh 29-year high above 1.0280 and the NZD/USD flirt with 0.7550. But it wasn’t just the global backdrop moving in support of the NZD last week.

Locally, Thursday’s 0.2% increase in Q4 GDP dispelled any lingering speculation NZ was re-entering recession, while Balance of Payments data showed the trend improvement in NZ’s current account deficit continues. Looking ahead, Thursday’s NBNZ business survey will be the highlight of NZ’s data week.

While its confidence measure may well go negative, following the earthquake, the real test will be in firms’ own-activity indicators. So long as these don’t fall too much, they will still infer decent growth for the economy as a whole.

We’ll also be keeping a close eye on Wednesday morning’s Fonterra milk price auction, for any evidence of further price slippage. It’s worth noting, last week’s NZD/USD gains look a little overstated relative to ‘fundamentals’.

Indeed, NZD/USD ‘fair-value’, as estimated by our short-term valuation model, held constant at 0.7100-0.7300 over the week. Still, whether or not we see a near-term NZD/USD correction back towards ‘fair-value’ will largely depend on USD sentiment, in our view. Any faltering in investors’ risk appetite, or improvement in sentiment towards the US economy (watch Friday’s non-farm payrolls), would act to support the USD, knocking the NZD/USD from its highs.

Majors

The USD strengthened against most of the major currencies on Friday, as hawkish Fed rhetoric underpinned modest gains in US bond yields. In contrast, the NZD and AUD managed to buck the firmer USD trend, thanks to generally buoyant risk appetite.

A surge in the AUD dominated traders’ attention through the first part of the night. Solid buying of AUD/JPY, combined with further recovery in investors’ risk appetite, propelled the AUD/USD to a fresh 29-year high a smidge below 1.030. The NZD/USD was dragged up to a 3 ½ week high in tandem. Indicative of improved risk appetite, global stock markets posted their 7th straight daily gain and the VIX index (a proxy for risk aversion) slid below 18%, after starting the week around 24.5%.

It seems evidence of strong growth in Europe and the US last week was enough to offset the risks to the global economy from Japan’s nuclear crisis and mounting European debt concerns. Elsewhere on Friday, a broad-based strengthening in the USD saw most of the major currencies post modest declines.

Helping to bolster USD sentiment, US government bond yields ticked up 3-5bps thanks to growing optimism about the US economy. Not only was the final estimate of US Q4 GDP growth bumped up to 3.1% (3.0% expected), but Federal Reserve officials Plosser and Lockhart suggested further quantitative easing was fairly unlikely.

Indeed, Plosser even cautioned a reversal of super-easy US monetary policy would be needed in the “not-too-distant future". Against the broadly stronger USD, the GBP/USD slipped from 1.6120 to around 1.6040 and USD/JPY jumped from below 81.00 to almost 81.50. The EUR/USD suffered a heavier fall, from 1.4180 to 1.4080, after ratings agency S&P downgraded Portugal to BBB (following Fitch’s earlier two notch downgrade) and EU leaders delayed increasing the size of the EU rescue fund (to €440b from €250b) to mid-year.

A solid reading of the March German IFO confidence index (111.1 vs. 110.5 expected) kept the EUR’s decline in check. Looking ahead, most of the key upcoming event risk occurs late in the week, with US non-farm payrolls and the ISM manufacturing index both released on Friday. A strong US employment reading would add credence to the Fed hawks’ views that the Fed’s super-accommodative stance needs a re-think.

Such a scenario would provide fundamental support to the USD. In the lead up to Friday’s payrolls, expect Portugal’s worsening debt crisis to remain in the lime light.

Mike Jones is part of the BNZ research team. 

All its research is available here.