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Entries for August, 2009

The bears remain in hibernation – for now

The currency, and financial markets generally, are largely in a holding pattern at present – the weakening GBP an exception – in part due to a lull in information releases, in part due to Northern hemisphere holidays and in part due to markets having reached a natural point of inflection. New information is probably required to shift sentiment strongly, one way or other. The US S&P 500 share price index is now 54% above its 6-Mar low. This is about where the rebound rallies ended for Italy and France in the 1960s, the US, Switzerland and Europe in the 1970s and Japan in the 1990s. There were post-crash rebounds at other times that have gone further but we are in the zone where the recovery glow has tended to wane (see Morgan Stanley on the history of bear markets). Meanwhile we also remain within the time of year most prone to share market falls and we have insiders selling while the general public are buying. And to cap it off, we know that governments will have to tighten monetary and fiscal policy at some stage over the next couple of years (the Chinese have started already, contributing to a 3.4% share market decline last week). This makes for nervous markets, and most likely volatility.

From a momentum perspective, the near-term bias is likely to be upwards, there being little to indicate that the ‘good news’ is about to stop. For the NZD, upward pressure is also likely to come from an RBA approaching the time of its first tightening (don’t discount the possibility of a surprise rate hike Tuesday – the Australian cash rate is at emergency levels no longer required and it is now 5 months since their last easing, the same gap waited back in 2002 before the first-in-the-cycle rate hike).

From a value perspective, current levels in the share markets and NZD appear over-priced relative to the risks ahead.

In sum, the NZD/USD at 70c remains a strong possibility. But that need not prevent the NZD/USD again reaching 60c before Xmas as well.

The risk of a second dip remains high

The goldilocks period continues for the global financial markets – the news at the margin is largely positive (the level of activity is not!) while interest rates are very low – and hence up go global share prices, the price of oil and along with them the NZD, including the NZD/GBP passing the same peak reached in 2005 and 2008 (but not the NZD/CAD). There is one major challenge to this scenario this week – the US government issuing another massive round of debt Tuesday, Wednesday and Thursday – but the lack of other major scheduled financial news suggests the momentum carries the NZD generally higher in the next few days, and maybe weeks. However it still remains difficult to see the NZD/USD, for instance, remaining above 70c over a period of months.

Background articles of interest …

1) Investor confidence is now high according to the Merrill Lynch monthly survey of global fund managers, the index reaching its highest level since Nov-03 – a warning to all contrarians (and, yes, the S&P 500 did drop in the first half of 2004, by 5%).

2) The challenge ahead: removing the massive US stimulus in place without derailing the economy, and while holding onto your job Yahoo

3) Of a similar theme, former Morgan Stanley Analyst Andy Xie believes we are amidst a pure liquidity bubble, a temporary equilibrium that depends largely on the US and Chinese governments and – as do the IMF – that a sustained recovery requires a rebalancing of US and Chinese savings rates. Some other observations: the Chinese growth rate is slowing right now; liquidity is fueling a rising oil price trend. And forecasts: the US Fed will start raising interest rates within 6 months; asset prices will weaken next year.

Back to the old ways

There is a growing sense that the worst of the global recession is over. There is also further evidence that conditions are improving in New Zealand. Meanwhile there are not many events due in the next couple of weeks to rattle confidence in the recovery scenario. This is a backdrop that would normally favour a higher NZ dollar, just like the old days.

The problem is that a return to the old days seems inconceivable; surely people and policy-makers will change their ways? Well, that is yet to be determined. Currently we can point to high levels of global liquidity. We can point to speculative activity in global assets markets. And we can point to central banks reluctant to act, for fear of derailing the recovery (or our central bank threatening “the OCR could still move modestly lower“). All reminiscent of 2003.

Eventually, though, there will be fiscal and monetary tightening. It is unlikely that any exit strategy will occur smoothly. Thus there is plenty of volatility ahead. It is tempting to anticipate this policy response by selling NZ dollars now but the NZ dollar is likely to move higher in the near-term.

Background articles …

1) Growth rates have proven to be generally better than feared in the June quarter (NZ and Australia yet to be reported) with growth in Germany and France amongst Europe, and generally in Asia. But overall output did decline in the Eurozone, as was the case in the US. Both paled besides Russia. These data, plus more recent figures pointing to improvement, have prompted economists to increase growth predictions (WSJ) for second half 2009. It appears the worst is behind us.

2) There has been more confirmation of a local recovery also: confidence up in the general monthly BNZ survey; pockets of regional job recovery reported by Hays Specialist Recruitment; greater confidence about housing in the quarterly ASB survey; and, more forward-looking, Infometrics forecast the fast-population, slow-construction mismatch to show as 11% higher house prices over 12 months.

3) In the US corporate world, 91% of US S&P 500 companies have reported June quarter results and the pattern is clear: US profits are still rising faster than expected for most but sales are still falling – down 5% in the quarter – and meanwhile corporates are sitting on near-record levels of cash; the market has re-rated share prices but not near-term earnings, thus pushing the P/E on prospective 12-months operating earnings higher but at 14.4 it remains below the 18-year average of 18.4. The implication: there is potential for further sharp share price rises IF sales growth were to emerge.

4) Here is where policy becomes relevant. At present the central banks are adopting a stimulative stance, such as the Fed maintaining “exceptionally low levels of the federal funds rate for an extended period“. But eventually they will have to unwind the huge monetary stimulus in place. When? Some point to 1937 and suggest the central bank response will be slow and gradual. But there is also the lesson of the too-slow US tightening of 2003-2004 to keep in mind.

5) Meanwhile signs of the old excesses are already emerging; on Wall Street; and in the local housing market with banks again offering high LVR loans and real estate agents talking of missing out.

Local green shoots means NZD stays with pack

The global financial markets continue to walk a tight rope. The momentum favours growth and rising share prices, and hence a higher NZ dollar. However there are serious questions over whether this growth momentum can be maintained next year, especially as fiscal and monetary policies are inevitably tightened. Central banks such as the RBNZ, BOE and ECB are downplaying any potential tightening and the US Fed will probably do likewise this week. Hence the NZD/JPY, NZD/EUR and maybe NZD/USD head higher for now, caught in the global risk-buying spree.

Key events shaping the future …

1) Leading indicators continue to point to higher near-term global production, consistent with output being raised to match demand that has now stabilised (but demand not necessarily increasing much). This output recovery theme does not appear to be finished yet (see Danske Bank for overview), and hence neither has the rising share market trend probably ended; in turn suggesting further upside for currencies like the AUD.

2) This global recovery is at last showing for NZ exporters, whole milk powder prices rising by 26% at the recent Fonterra auction. Meanwhile local retail spending edged higher in July (Paymark) and the continued housing recovery in July (Barfoot) suggests more spending growth to come. These news items should be sufficient to see the NZD stay with other rising currencies such as the AUD and BRL.

3) However the NZD is likely to lag, rather than lead, the AUD higher judging by the relative interest rate shift last week: interest rates are priced to increase in both countries next year (in spite of the RBNZ’s warning of possible further easing) but Australian 90-day bank bills rates are now expected to be 1.2% higher by March (up 0.4% last week) while the equivalent NZ rate is expected to be 0.5% higher (up 0.1%). This implied rising interest rate differential is likely to see the NZD/AUD remain low in the weeks ahead.

4) Interest rate differentials also look likely to play a greater role in the major exchange rates. Higher US yields last week saw the USD/JPY rise and EUR/USD fall. While this stalled the NZD/USD rally, it also accelerated the NZD/JPY rally and NZD/EUR rallies. Rising share prices will likely see these later two trends persist.

5) Just how much US interest rates are about to rise will become clearer this week following the FOMC meeting (see Calendar). The US Fed are expected (see Bloomberg) to allow their Treasury-buying programme to end (having bought around one-third of Treasury bonds issued since late March). But they will still buy large volumes of mortgage-backed-securities through to year-end and, using other central bank as a guide, will probably still be emphasising easy conditions rather than focusing on an exit strategy (just yet).

Global forces over-ride RBNZ

Earlier in the week it appeared the NZD might finally drop but it was not to be. It soon became clear that the global appetite for risk is the dominant force at present and it now looks like the NZD/USD will be dragged higher by global forces in the near-term, probably to 70c. However there remains the risk that any near-term rally proves short-lived.

Key events shaping the future …

1) The AUD/USD pushed through its early-June high. This is the key pressure on the NZD. Tellingly, the AUD/EUR continues it climb towards the trading range of the previous 5 years (centred on 60 euro). The RBA now appear to have removed an easing bias, the Governor referring to upside risks. Look for more on this view at the 7-Aug Statement of Monetary Policy but meanwhile any bullish Australian data release (see calendar) will push the AUD higher.

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2) The backdrop to the AUD rally is another surge in global risk investment. Shares and commodities generally rallied last week. There was a taste of things to come when the Chinese Shanghai Composite Index of shares dropped 8% at one stage Wednesday following central bank tightening. However the lack of follow-through overnight in other markets and the quick return to rallying Chinese shares are signs of strong demand for risk at present.

3) Another bullish equity technical indicator was triggered. The Dow Jones crossed 10% above its 200-day moving average, a milestone that 18-out-of-21 times has been followed by 3-month gains. Behind the current rally is the higher-than-forecast earnings of about three-quarters of the 148 companies in the S&P 500 that released June quarter results last week.

4) Of course, there are other ways to read from the past. A US researcher lists 7 signs that would mark a secular bottom to US share prices and suggests the low point has not been reached yet – the current level of debt being a major constraining factor. (A technical parallel to this fundamental view is the Elliott Wave interpretation that the S&P 500 rallies another 5% before dropping sharply).

5) Also something to keep in mind further down the track, the US and Chinese authorities appear agreed that they would prefer a stable US dollar. Stability will not happen but these comments do hint at policies to support the US dollar to come eventually (or at least not to further weaken it).

6) Our own authorities are also unhappy about the NZ dollar, judging by the RBNZ warning of ‘further easing in financial conditions’. This is reason to believe the NZD/AUD stays low but, as the quick NZD/USD turnaround Friday showed, it is global forces that are more dominant on other NZD cross-rates.

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