fxmatters

The stand-off continues. Share prices pushed higher. Significantly for some traditional analysts, the Dow Jones Transportation Index surpassed recent highs. Commodity prices were up. The ‘risky’ currencies such as the NZD, AUD and HUF appreciated and the low-cost JPY depreciated. All signs of a greater appetite for risk. And yet the currency moves remain unconvincing (the NZD edged up to a new high at 66.28c but not so the AUD, CAD, EUR or GBP – likewise for a wider set of risky assets), while the general risks around economic growth and company profits remain high. I still believe these are good opportunities for people looking to sell but a very risky time to be buying.

This week sees the RBNZ once again decide on the Official Cash Rate. No change to the 2.5% current rate is expected. The RBNZ appear caught between a rock and a hard place (as usual): they will be concerned that a rising NZD will curtail any export pickup but they will not want to fuel any faster housing recovery by reducing the cash rate. The net effect may be to prompt the Governor to warn about the need for restraint with debt accumulation, and to state the RBNZ’s willingness to consider more direct means to slow credit growth in future.

So much for a weak US share market in July, or at least the 7% S&P500 surge last week did not indicate weakness. Unfortunately movements of this magnitude are more a sign of the volatility and uncertainty at present rather than a compelling signal of confidence (5 of the last 7 weeks with 5%-plus surges have been followed by a weekly decline!). Importantly the earnings season is only just starting, with only 38 of the 500 S&P500 companies having reported so far.

The most likely scenario remains a broad sideways pattern for global financial markets, including the NZD, while the risk of a sell-off of risky assets cannot yet be dismissed. Tellingly, the S&P500 remains below its June high; likewise the major currencies, including the NZD, against the USD. Very little is ever certain about the future but current trading still looks more like noise.

Support for a scenario of general financial market sideways movement came from two quarters last week: Morgan Stanley forecast the US government 10-year bond yield to range trade between 3-3.75% over most of second half 2009 (any growth surge being tempered by underlying subdued US consumption growth – sound familiar?); and CBA predict the oil price to broadly centre on US$60/barrel for the rest of the year (there being excess supply available to meet any demand increase).

The NZD/USD slipped further last week, mainly on the back of global risk aversion (the JPY was strong and share prices dropped) and other negative influences on the AUD (RBA say there is scope for further easing of monetary policy, commodity prices declined and there was the unusual cancellation of a Chinese coal shipment).

At 62.8c (Saturday morning), the NZD/USD is still within 1% of its average rate since entering the current trading range during the week ending 22 May. In other words, the NZD/USD is down but there is little evidence at present to suggest it is doing little more than trading in a broad sideways pattern.

That would not be unusual. In the last four years the NZD/USD market has existed in such states approximately half the time e.g. the NZD/USD ranged about 2-3c either side of a 62.4c average for 23 weeks between Mar-06 and Aug-06. At other times the period of range trading was longer. Seen from this perspective, the current ranging period of 7 weeks so far is brief.

Eventually, though, the NZD/USD (and other NZD rates) will trend again. As mentioned in previous weeks, there is a strong chance in the near-term that any break would be downwards. As time goes on, the risks for the NZD/USD swing more to the upside as the sheer volume of offshore-owned debt in the US weighs on the US dollar itself.

The NZD showed outright weakness last week, falling against the other 37 currencies monitored here. Several factors have been blamed including lower global share prices and lower dairy prices (although not for 2010 deliveries). While tempting to extrapolate the NZD weakness forward, it should be recalled that the NZD has been the weakest of the 38 currencies in 8 weeks from the last three years but was lower one month later only three times. As always, recent changes are not necessarily good predictors of future exchange rate movements.

Local news this week are likely to be more upbeat, including improving business confidence and more house sales (but a still flat retail sector). Globally it will probably be the G8 meeting July 8-10th that commands attention, particularly the issue of a replacement reserve currency for the USD. Any radical change seems unlikely in the current environment, and more likely soothing words will be expressed when Presidents Obama and Hu have a sideline meeting.

In other words, markets remain at a crossroads. The biggest near-term risk appears to be of further share market weakness, and hence a lower NZD, especially with the backdrop of a weak NZ economy and maturing Uridashis.