Risk goes back on as Euro worries ease and US data surprises

The NZD had the dubious honour of being the best performing currency over the past 24 hours. The strong risk-on theme saw NZD/USD surge to a fresh post-float high around 0.8570, from around 0.8450 yesterday.

The NZD trade-weighted index continued to march higher, up 0.9% to 73.90. NZD/GBP has forged a fresh post-float high around 0.5310. NZD/EUR rallied from around 0.5990 to above 0.6050 currently, its highest level since December 2005. NZD/AUD briefly broke through 0.8000, but has settled back around 0.7970 currently.

For now, the NZD remains well supported by relative interest rate differentials. The 3-year NZ-UK and NZ-EU interest rate differential currently stands around 2.27% and 1.75% respectively. The most notable interest rate difference is between NZ and Australia, where the OIS is expecting 80bps of hikes from the RBNZ, but has 50bps of cuts from the RBA over the next 12 months.

Overnight, the NZD shrugged off another weak Fonterra milk auction, with average milk prices falling 5.1%. Milk prices are now down 13.5% since early June and down 20% from early March. The recent declines are starting to question Fonterra’s payout forecast. Probably not enough to cause a downward move, but we would not want to see global prices ease much further and/or the currency push even higher. Keep an eye on both.

Yesterday’s RBA minutes were seen as confirming current interest rate pricing in Australia. In particular, the RBA removed the reference to a need for tighter policy ‘at some stage’. Barring a serious collapse in global confidence and activity, our NAB colleagues still expect a rate hike in December. In response to the minutes, AUD/USD dropped to 1.0610 but these losses have been more than reversed overnight.

Today, with no data releases locally, direction on AUD and NZD will initially be gleaned from the release of the AU Westpac leading index and consumer inflation expectations survey.

Majors

The USD has fallen against nearly all the major currencies overnight, except against the “safe haven” CHF and JPY. Improved risk appetite has lead to selling of the USD.

The bounce in risk appetite was broad based across asset classes. Equity markets have pinged higher, with the S&P500 index and Euro Stoxx 50 index up 1.6% and 1.3% respectively. The VIX (proxy for risk aversion) fell from 21.0 to 19.6. The CRB (broad index of global commodity prices) rallied 0.8%.

The risk-on theme started early in the evening after rumours circulated the EU summit was being brought forward to tomorrow. This caused speculation a second bail-out package for Greece would be announced. However, later in the evening German Chancellor Merkel hosed-down such expectations, noting no ‘big and quick’ solution will be announced at the meeting.

The move higher in the EUR was supported by some narrowing in ‘peripheral’ European CDS spreads. Over the night, EUR/USD traded up from 1.4110 to a high around 1.4220, but has given these gains up late this morning to trade around 1.4130.

The risk-on sentiment was bolstered by  better-then-expected US housing starts for June (14.6% vs 2.7% m/m expected) and building permits for June (2.5% vs -2.3% m/m expected). The USD fell in response to the data, as risk seeking investors searched for higher yielding currencies. The decline in the USD was tempered late this morning after a deficit-reduction plan was proposed by the bipartisan "Group of Six" senators, raising hopes an agreement to raise the US government’s debt ceiling is getting closer.

The risk sensitive NZD and AUD surged higher overnight. The AUD was given a further boost as articles from noted RBA watchers McCrann and Mitchell suggested the chance of a rate cut was very slim. Overnight AUD/USD has surged from around 1.0620 to 1.0720 currently.  

The CAD was given a further boost early this morning after the Bank of Canada (BoC) delivered a more hawkish policy statement. The BoC kept its policy rate unchanged at 1%, but noted they expect the economy to expand faster in H2 this year, and inflation to hit the 2% target sooner. USD/CAD immediately shed ½ a cent to 0.9500, its lowest level since early May. The OIS market is now pricing around 47bps of hikes from the BoC over the next 12 months, from 45bps yesterday.

Looking to the night ahead, expect the European debt crisis and US debt ceiling debate to dominate currency direction. Data-wise, markets will be looking to the BoE minutes for any snippets about the possibility of further asset purchases.
 
Fixed Interest Markets

There was a little more upward pressure on NZ short-end yields yesterday, with further curve flattening.

NZ 2-year swap rates inched a little higher to close at 3.51%, having now broken out of their trading range of the past 3 months. 10-year yields closed unchanged at 5.17%. Bonds showed similar tendencies, with the yield on 13s rising 5.5bps to 3.35%, while 21s were steadier at 5.02%.

Overnight, US 10-year yields eased a little lower from 2.92% to 2.88%. In the US debt saga, President Obama endorsed a deficit-cutting proposal that was tabled by a bipartisan group of senators. However, much negotiation is still required. While all attention has been focused on global government woes, the Q2 US corporate earnings season has quietly made a solid start. With 36 of the S&P500 companies now reported, 31 have surprised positively. Earnings growth stands at close to 20%y/y.

In Europe, peripheral country yields fell from recent highs overnight. Yields on 10-year Spanish and Italian bonds fell to 6.10% and 5.73% respectively. Talk has been revived regarding the introduction of ‘euro-area bonds’ in an attempt to address the rising cost of funding by such countries. The proposal is not popular with Germany, as its own borrowing costs would rise, in such a pooled proposal.

Australian yields have bounced off their recent lows. After the release of RBA July minutes there was no meaningful change to OIS market expectations for 50bps of cuts from the RBA in the coming year. NZ-AU 3-year swap spreads hold onto their recent shift higher, hovering around -0.99%.There are no NZ data releases today.

See our interactive swap rates charts here and bond rate charts here.

Mike Burrowes and Kymberly Martin are part of the BNZ research team. 

All its research is available here.