New Zealand Dollar Selling Ahead If Stock Markets Turn Lower

Fundamental Outlook for New Zealand Dollar: Bearish

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The New Zealand Dollar may see considerable selling pressure in the coming week as a downward reversal in global risk appetite weighs on high-yielding and commodity-linked currencies. Risky assets look decidedly vulnerable, with the MSCI World Stock Index trading at the highest level relative to earnings since August 2004. In real terms, the world economy grew at an average pace of 4.1% that year, whereas virtually every credible forecasting outlet including the IMF, OECD, World Bank, and assorted central banks all call for global GDP to shrink this year and rebound only modestly in 2010. This suggests shares are overvalued, pointing to a forthcoming correction downward as the euphoria that began in March subsides. Technical positioning suggests this may happen sooner rather than later, with the Dow Jones Industrial Average showing a well-defined Head-and-Shoulders topping formation. A trade-weighted index tracking the New Zealand Dollar’s average value against top global currencies is now 91.5% correlated with the Dow and 92.8% correlated with the broader MSCI metric (using a 90-day rolling correlation), suggesting that any major selloff in risky assets put tremendous downward pressure on the smaller antipodean currency.

Turning to the economic calendar, the docket is decidedly uneventful. Leading indicators suggest the second-quarter edition of the NZIER Business Opinion Survey may tick higher after printing at a record-low -65 in the three months to March: the NBNZ measure of business confidence rose steadily in the second quarter, printing in positive territory in May for the first time since September 2008. Still, it remains to be seen if positive momentum can be maintained considering the soaring public deficit has seen Prime Minister John Key’s government abandon a hefty portion of the fiscal stimulus measures that had been included in the latest budget. Indeed, additional monetary easing may be in the cards in the weeks ahead despite RBNZ Governor Alan Bollard’s forecast that that economic growth will pick up by the end of this year. - IS