New Zealand Dollar Fundamentals may Soon Overwhelm Risk Appetite

The New Zealand dollar is living on borrowed time. Risk appetite single-handedly lifted this currency from a six-year low following the hit it took during the worst financial crisis in modern history; and it is only a matter of time before the aggressive rally collapses under it s own weight. Is this kiwi dollar really destined to pace investor sentiment? Yes. Not only does the currency maintain a yield that through history has kept a significant premium over its counterparts; but its mere presence among the list of most liquid currencies can be attributed to its appeal as a place to park capital. In fact, under most scenarios (even a revival in the demand for yield); it is likely that the kiwi will not only retrace its gains but it may actually pace the over-due correction.

While it is possible that the New Zealand dollar could struggle or tumble even if sentiment is steady or rising; it is best to first cover the most direct fundamental scenario: a plunge in risk appetite. Though the Dow Jones Industrial Average and Gold closed their respective weeks at new highs for the year; there is growing skepticism among the trading ranks that the drive can hold up for much longer. Measuring the conviction for both of these markets, volume for both hit new monthly lows. From a more historical perspective, we haven’t seen a rally from equities of this magnitude in recent history. From technical review to fundamental assessment, it is not a stretch to propose values have run astray of the economics that support them. The return of idled investor funds from the harbor of safe haven assets back into the speculative arena has filled in for the lack of reasonable yield income with the thrill of capital gains. However, eventually a balance will be struck where the speculators will be tapped and what remains to be invested will belong to those managers that are cautiously awaiting the return of dividends, yields and other stable rates of return. When the tides turn, the collapse from profit taking will likely be more severe (though not as deep) as the initial rally.

When risky positions begin to be unwound in masse, those securities with a weak fundamental foundation will see bleed capital the fastest. Therefore, a currency like the Australian dollar may see a retracement but it will be measured thanks to its ability to avoid recession and the promise of a hawkish rate regime. In comparison, its New Zealand counterpart finds its economic is still struggling to forge a recovery and the central bank has vowed to hold its benchmark lending rate at its record low 2.50 percent until late 2010. What’s more, the previously overlooked warnings by RBNZ Governor Alan Bollard that the kiwi was overbought and is solely rising on the basis of speculative flows will suddenly come rushing back as the market starts to turn. In the meantime, we will keep tabs on the economy’s and central bank’s pace. Event risk over the coming week is relatively light but upstream inflation numbers and credit card spending figures will offer a look at two key concerns for the policy authority.

Australian Dollar Looks To March Higher Absent Risk Aversion

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Australian Dollar Looks To March Higher Absent Risk Aversion

Fri Nov 13 22:12:00 GMT 2009 | Written by John Rivera

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• Nov, 07 Australian Dollar Rally May Continue if Risk Appetite Remains in Play

Australian Dollar Looks To March Higher Absent Risk Aversion

Fundamental Forecast for Australian Dollar: Bullish

- Australian economy unexpectedly added 24,500 jobs in October, equaling a six year high
- Westpac Consumer Confidence Fell for the first time in six months by 2.5%
- Consumer inflation expectations fall to 3.2% from 3.5% in October


The Australian dollar rose to a fresh yearly high of 0.9368 against the greenback as continued risk appetite and unexpected job creation in October fueled bullish sentiment. Equity markets continued push higher with the Dow setting a fresh yearly high as traders took comfort in the G-20’s pledge to maintain low interest rates and stimulus programs. However, the RBA isn’t expected to follow the pack as they have already raise rates at their last two policy meetings and markets are currently pricing in an 83% chance that they will continue to tighten at their December (November 30th ) rendezvous. The prospect of higher borrowing costs led to 2.5% drop in consumer confidence, the first in six months. Confidence remains relatively high, but declining optimism could negatively impact domestic consumption which unexpectedly fell 0.2% in September.

The weak demand had raised the prospect that the RBA would take a break from their tightening policy at their December meeting as there are concerns that premature rate hikes could derail the recovery. Additionally, Governor Stevens last week signaled to markets that the strength of the Australian dollar would limit upside inflation risks and give him the scope to slow the pace of future rate increase. However, the surprising job growth re-established expectations for an additional 25 bps hike as it reaffirmed the Governor Stevens statements following November’s meeting that “there have been some early signs of an improvement in labor market conditions. The rate of unemployment is now likely to peak at a considerably lower level than earlier expected.”

The upcoming economic calendar may only add to the likelihood of a rate increase as the wage cost index is forecasted to show a 0.7% rise in the third quarter, adding to inflation concerns. Westpac’s leading index which tracks eight gauges of activity, such as company profits and productivity, to give an indication of how the economy will perform over the next three to nine months is also due for release. If it continues its current trend of improvement then the brighter outlook for growth will add to the case for future tightening. Rising interest rate expectations will continue to be a supporting factor for the Australian dollar which could see the com-dollar eventually look to test its all-time high. However, the RBA will release their minutes from their November meeting which could hint at the prospect of keeping rate steady at their next meeting which could weigh on the Aussie. Additionally, the high yielder loses its attractiveness if risk appetite wanes which could be the case this week with equity markets up against technical resistance levels.

Canadian Dollar Strength May Hinge on Break in Oil

The Canadian dollar was one of the strongest major currencies over the past week, but this was mostly the result of broad US dollar weakness rather than commodity prices since oil prices continued to consolidate between $77/bbl and $80/bbl. Furthermore, fundamental forces didn’t really play into the currency’s moves as there was no major economic data on hand. That said, the one notable indicator was released on Friday, when data showed that Canada’s trade deficit narrowed to a three month low in September. The deficit eased to C$927 million from C$1.99 billion in August thanks to a 3.5 percent increase in exports, suggesting that foreign demand may help to alleviate some of the nation’s economic woes. Going forward, a break in either direction for oil is likely to translate into a similar move for the Canadian dollar versus the US dollar, but the trend remains in favor of Loonie strength.

Overall, upcoming economic reports out of Canada are anticipated to reflect improving conditions. On Monday, manufacturing sales for the month of September are projected to rise by 1.7 percent following a drop of 2.1 percent in August, but the actual results could prove to be even better given the jump in exports during the same period.

On Wednesday, the annual rate of Canadian headline CPI growth for October is projected to bounce back up to 0.1 percent from -0.9 percent, while the Bank of Canada’s core measure is projected to rise to 1.7 percent from 1.5 percent. Such results would suggest that higher commodity costs are providing some support for the headline CPI measures, while improving domestic demand has lifted broader prices. The Bank of Canada said in their most recent policy statement that “overall risks to its inflation projection are tilted slightly to the downside,” but if we see both headline and core measures of CPI climb higher than expected, the Canadian dollar could rally.

Finally, on Thursday, international securities transaction may show that foreign demand for Canadian assets waned in September to C$3.0 billion from C$5.082 billion. On the other hand, wholesale sales are estimated to rise 1.0 percent for September, which would bode well for the November 23 release of retail sales as a gauge of domestic demand.

Swiss Franc to Hold Range as SNB Pledges to Maintain Policy

The Swiss Franc ended the week higher against the U.S. Dollar and the Euro, with the USD/CHF continuing to push toward parity as the pair slipped to a low of 1.0034, just 2pips shy of the yearly low at 1.0032, and low-yielding currency is likely to remain range-bound over the following week as investors weigh the outlook for future policy. SNB member Thomas Jordan reaffirmed the central bank’s policy stance during a speech earlier this week and said that the board has reached its goals and does not see any reason to shift policy as it aims “to support an economic recovery during a difficult phase without low rates and an elevated liquidity creating an inadequate evolution.” In addition, Mr. Jordan continued to voice his concern about the marked appreciation in the Swiss franc, stating that “the exchange rate has quite an important impact” on the economy, and went onto say that the central bank’s efforts to stem the rise against the euro were largely “successful.” Moreover, the board-member said that central bank will look to normalize policy over the medium-term as conditions improve, but noted that the outlook for the global economy remains highly uncertain and pledged to support the economic recovery in the short run. At the same time, SNB Governor Jean-Pierre Roth expects to see weaker growth following the crisis, and said that the slump in employment remains a concern as growth prospects remain subdued. As policy makers maintain a cautious outlook for the region and vow to prevent a further appreciation in the exchange rate, the low-yielding currency may continue to trend sideways as investors weigh the prospects for another SNB intervention. Nevertheless, the economic docket for the following week could stoke increased volatility in the Swiss franc cross rates as the Swiss National Bank holds an improved outlook for growth and forecasts GDP to expand at an annual rate of 0.4% in 2010 amid an initial forecast for a 0.4% contraction.

British Pound Forecast Bullish Versus Euro but watch for BoE Surprises

The British Pound survived a week of fairly lackluster fundamental developments to trade marginally higher against the US Dollar, but a busy week of economic event risk may pose further challenges for the UK currency in the week ahead. Early-week news that Fitch Ratings took a “cautious” view on its outlook for the UK Government Bond’s AAA sovereign rating rattled markets and sent the Sterling instantly lower. The following Bank of England Quarterly Inflation report expressed a similarly cautious outlook for economic growth, and it seemed like the GBP was headed for a break of key support against the US dollar. Yet traders clearly had other things in mind, and the GBPUSD held key technical levels through the week’s close. Whether or not the pair can sustain its defense will likely depend on key event risk in the days ahead, setting the stage for another eventful week of British Pound price action.

Consumer Price Index numbers and mid-week Bank of England monetary policy minutes will likely be the major highlights in the week ahead, but traders should likewise keep an eye out for late-week UK Retail Sales results. Inflation and BoE outcomes will almost certainly cause volatility in UK interest rate expectations and—by extension—the British Pound. The currency rallied sharply through the Bank of England’s most recent interest rate announcement as officials boosted Quantitative Easing measures by less than expected. Traders will want to see the voting for that decision and general commentary on the future of monetary policy, while the previous day’s CPI data will likewise play a large part in determining monetary policy forecasts. Current consensus forecasts call for a modest rise in year-over-year inflation rates, and it is admittedly difficult to handicap likely reactions to the event. Lofty expectations for later-week Retail Sales numbers, on the other hand, leave large room for disappointment.

The British Pound has thus far been able to hold key technical and psychological support versus the Euro and US Dollar, but traders’ resolve will likely be put to the test in the week ahead. We have long called for GBP outperformance versus the Euro on clear sentiment extremes. According to US CFTC Commitment of Traders data, Non-Commercial traders remain fairly heavily long the EUR/USD and short the GBP/USD—giving us a fairly bearish EUR/GBP bias. Yet positioning has thus far eased considerably from previous extremes, and the British Pound is at clear risk for losses on continued disappointments in domestic fundamental developments. All else remaining equal, we expect the British Pound to break the psychologically significant 0.8900 mark against the Euro, but our forecasts will likely be put to the test in the week ahead.

Japanese Yen Likely to Range Trade Against the US Dollar

Continued S&P 500 rallies made the safe-haven Japanese Yen the second-worst performing G10 currency to finish the week’s trade, finishing higher only against the similarly-downtrodden US Dollar. All major world equity indices finished anywhere from 2-3 percent above their weekly open except for the Japanese Nikkei 225—raising serious doubts on investor demand for Japanese financial asset classes and reflecting poorly on the domestic currency. Indeed, the fundamental arguments for Japanese Yen strengths are becoming increasingly scarce—especially through times of healthy financial market risk appetite.

Week in and week out, we have repeated that financial market risk sentiment and the trajectory of the S&P 500 would be the major determinant of USDJPY price action. Yet the US Dollar has actually taken top-billing as carry trade funding currency as it now carries the lowest overnight yield of any major world currency. The truly substantive shift in interest rates has meant that the USDJPY’s correlation to risky assets has fallen considerably from its heights, and it is admittedly unclear whether the USDJPY would decline on S&P 500 tumbles. In fact, the rolling correlation between the US Dollar Index and S&P is very near record-highs—emphasizing the Dollar’s sensitivity to risk sentiment.

The Japanese Yen may subsequently struggle to find a bid against the US Dollar as it trades near substantive highs. The confusing US Dollar/Japanese Yen links to risk sentiment likely explain low volatility expectations for the currency pair, and it seems traders are pricing in range trading for the often fast-moving USDJPY. This stands in fairly stark contrast to volatility expectations for other major currencies—theoretically providing safe haven for range traders and scalpers in the week ahead.