fxmatters

The news continues to be universally bad and governments are working overtime to produce rescue packages. Against this backdrop it remains difficult to see any of the major currencies as a safety haven. We also appear to have reached a plateau in the cash rate cuts by the major central banks, the ECB having signaled taking time to reflect at the February meeting and the US Fed widely expected to decide this week to hold the cash rate but instead act to keep longer-term US rates down. In all, the near-term outlook is still one of broad sideways trends, maybe the EUR/USD largely within $1.28-$1.34.

However, rate cuts are far from finished in this part of the world. The RBNZ are set to cut the cash rate by at least a 1% to 4% p.a. this week, according to market pricing. That would be below Australia for the first time since Jan-04. But not for long: the RBA are likely to drop their cash rate by 0.5% to 3.75% on 3-Feb. The NZD and AUD will probably show downward biases heading into these announcements.

Longer-term the statistic that caught my eye last week was the US 8% of GDP government spending deficit (average of global forecasters). Such a level of debt accumulation is likely to weigh on the USD eventually (and thus provide upward pressure on the NZD/USD), possibly before the year is out.

Risk returned last week in many guises, with NZ to the forefront. Generally weak activity/profit figures (globally) and potential credit-rating downgrades (NZ, Portugal, Spain and a downgrade delivered for Greece) were the key themes.

However there were some hopeful signs: many share markets rallied on Friday, and the EUR/JPY appreciated; while fiscal and monetary stimuli continued to be delivered. The global tension between fear and hope is likely to persist in the weeks ahead (rather than one dominate) and hence the most likely scenario remains the major currencies trading within a broad sideways pattern (recall the low points for the EUR/USD and AUD/USD were now 12 weeks ago and these trends are key determinants of the NZD/USD). This suggests a strong chance that the NZD/USD remains above 50c.

But there is a major difference between Oct-08 and now: it is starting to hit home just how much the global difficulties will impact on NZ output/profits and, consequently, on NZ government finances. Two sharp jolts were delivered last week in the form of very weak business confidence and a downgrade warning for the Government’s offshore credit rating. The net effect was a quick narrowing of the gap between NZ and Australian interest rates (see Interest Rate Futures). The RBNZ rate is likely to deliver another large rate cut 29-Jan (maybe 1%) and, consequently, the NZD is expected to experience general weakness heading into the announcement.

All in all, this confluence of global and local forces suggests opportunities to buy NZD/USD near the bottom of the recent range will emerge while the NZD/AUD cross-rate could slip below 80c near-term.

The seemingly schizophrenic nature of financial markets has continued into 2009. The end result are currency trends that are broadly sideways. The one thing agreed is that 2009 will be tough for all economies. But mostly the talk is a of global recession – not depression – with the massive policy response by governments expected to limit damage in terms of job losses.

Given that financial markets are largely forward-looking, this line of thinking implies a sizable rebound at some stage this year in those markets worst hit in 2008, especially equities in general and currencies such as the EUR, AUD and NZD. Conversely the USD is likely to decline (especially given that the US is at the core of global problems and at the head of the monetary response). In sum, a higher NZD/USD by year-end is likely (say 70c).

However such NZD strength will require a EUR/USD rally, and the EUR is unlikely to appreciate sustainably until such time as the worst of the ‘bad news’ in Europe has been delivered. This does not appear to be the case at present. Perversely a strong rate cut by the ECB Thursday night may bring forward expectations of this turning point and hence kick-start a sustained rally against the USD. But the hints coming from the ECB suggest conservatism – and hence a drawn out slowdown. So the ‘weak USD scenario’ may have to wait a few months yet.

In the meantime the extent of the local monetary response comes into focus once more. The RBNZ (29-Jan) and RBA (3-Feb) are expected to cut rates again, especially if inflation is reported lower than expected beforehand (see Calendar).

In sum, the NZD could well be higher by year-end but there will be plenty of volatility along the way, including probably some buying opportunties in the lead-up to the next RBNZ easing.