fxmatters

The mixed messages keep coming. Last week Standard & Poor’s lowered its outlook for the UK’s top-notch AAA rating, raising fears that the US may face a similar fate soon. By the end of the week, though, it was the GBP that had strengthened 4.9%, just behind the leading group of currencies rallying against the USD (topped by the Hungarian Forint +6.3%).

Late Friday there was also news that the US government will follow the European lead and raise the subsidy on US dairy exports. The NZD/USD did dip this morning but it is still up 5.4% over a week and a morning.

Behind the rallying ‘risk’ currencies is the green shoots scenario. Faith is growing that we have turned the corner in the financial crisis and the consequent global recession. This may not have pushed share prices up sharply last week but it did have a significant impact on currency markets.

In particular it places currencies such as the GBP and EUR above the trading ranges of previous weeks. For technical traders – and they form a large proportion of the market – the rally has created bullish indicators such as the EUR/JPY 50-day average crossing above 200-day average. The momentum shown, and the likely supporting fundamental reports to come, imply further upside risk for the NZD.

As suggested a couple of weeks ago, 63c is a likely place for the NZD/USD to stall but the odds of a NZD/USD within the 65-70c range are rapidly increasing.

The reaction to the risk-accumulation of earlier weeks came last week. Prices were down across a number of asset classes, including the NZD, and the JPY was up. This is likely, though, to be a check in the rally rather than a full-scale return to the pessimism of earlier this year.

The bad news does continue – Eurozone GDP down 2.5% in the March quarter – but the forward-looking economic indicators still point to improvement ahead, or at least stabilisation. Meanwhile US corporates continue to report lower earnings but not generally as bad as feared. This theme of “things are bad but are not getting any worse” is likely to be repeated this week: declining GDP in Japan but stabilising housing markets in the US and improving sentiment in Europe. Keeping downward pressure on markets for now is likely to be anticipation of General Motors in bankruptcy.

The local markets have stayed with the global trends and appear likely to do the same this week.

There are two currency trends of note for the NZD. First, for all the talk of green shoots, the major three currencies remain largely range-bound. Once again people were keen to sell EUR/USD when it approaches $1.38 (hence the NZD/USD recent peaks in the low 60s this year). There would be nothing unusual about the EUR/USD sliding another 1-2%; hence a NZD/USD around 57.5c is possible near-term.

The second trend is the gradual strengthening of the AUD. There is little to suggest this trend has ended. It is likely to resume once equity markets start rising again. And it could resume without an equity market rally should, as will happen eventually, the currency-equity correlation ceases. An upward trending AUD will drag the NZD generally higher (although not the NZD/AUD).

In sum, look for buying opportunities for the NZD.

A big week for risk: the S&P 500, commodities such as oil and silver, currencies such as the NZD, AUD, BRL, HUF, MXN – all up over 5%. So much for stressed banks and declining global output; the focus is clearly on improving – but generally still negative – business sentiment. A swing upward in the OECD leading indicator for April to be released Monday is likely to frank this mood change (and hence maybe kick risky assets higher again).

The big question is when – not if – this risk-buying momentum stalls. The global problems have not gone away but rather the extreme pessimism of early 2009 is dissipating. Rather than venture a guess as to when such a stall may occur, two milestones are noted here for now:

• a sustained change in sentiment will need to show in real economic measures soon, suggesting April industrial figures for China (Wed) and the US (Fri) will command greater attention than normal (see Calendar).
• and any AUD/USD rally is likely to stall around 80c, implying a NZD/USD cap for now around 63 cents.

It appears we have passed many of the hurdles put in front of the NZ dollar rally with flying colours: the RBNZ rate cut was aggressive but in this mood of recovery anticipation it was taken to increase the chances of local growth; the RBA did not ease and this time the fact that they did not need to act was taken as evidence of imminent Australian recovery; the NZ unemployment rate did rise to 5% in the March quarter but this is hardly evidence of widespread job losses (and meanwhile NZ wages are still increasing!); the US bank test results have been delayed until tonight but the leaked results and bank share prices rallies suggest some comfort with results already known to the banks, and anyway Warren Buffett thinks Wells Fargo a great buy irrespective of what some bureaucrats think.

The coming hurdles of the RBA Statement and Australian budget appear modest against this background. Likewise the NZ Budget later in the month, especially given the hints that the Treasurer is working hard to avert a budget blowout and hence a credit rating downgrade.

The remaining key risks are the Australian employment figures this afternoon and the ECB announcement tonight. For all the local currency strength, the larger picture remains of a broad sideways pattern amongst the major currencies. The ECB comments tonight have the potential to drag the euro lower, and hence dampen the extent that the NZD and AUD rally against the USD.

But it does appear that the ‘green shoots’ scenario has taken hold and risk is back in favour. Currencies such as the NZD and AUD continue to be grouped with shares as a ‘risky’ asset class. The general trend for each is upward under an imminent global recovery, the AUD more so because, as RBA Governor Stevens said recently, “There are rather few countries that have the potential to offer so attractive a proposition to international capital” [as Australia].

However the evidence for a imminent global recovery is tentative. There are also many yellow shoots as discussed by New York Professor Roubini, who warns that a US recession may not end until 2010.

This suggests a tentative approach to currency trading as well. Work with the upward NZD for now. Expect an upward NZD trend over the next twelve months. But also expect some very choppy movements along the way. Right now the upside potential appears to be greatest for the NZD/EUR and least for the NZD/AUD.