NZ$/US$ almost gets to 0.88 as US debt ceiling crisis goes down to the wire

NZD
The NZD was one of the best performers against the USD on Friday, trailing just behind the “safe haven” CHF and JPY. The NZD/USD charged to a fresh post-float high just shy of 0.8800, from around 0.8650 early Saturday morning.

The NZD was propelled higher by strong flows from the leveraged and speculative community, mainly scrambling to cover short positions throughout the NY session. We also noted strong month-end fixing demand.  The other commodity-sensitive AUD and CAD struggled on Friday night, as they were more affected by poor risk sentiment.

NZD/EUR jumped from around 0.6080 to above 0.6110, just below of its highest level since December 2005. NZD/GBP hit a fresh post-float high at 0.5360, moving from around 0.5320. We expect relative interest rate and growth differentials to keep these crosses well supported over the next 12 months.

The NZD/AUD cross marched higher from 0.7900 to around 0.8000. Interest rate differentials continue to support the cross, with the 3-year differential moving to -90bps, from -97bps. Expect trading to remain volatile on the cross over the week ahead with important data due for release on both sides of the Tasman. On Tuesday, the RBA is expected to keep rate unchanged, but given last week’s strong CPI number expect a more hawkish statement.      

The local highlight this week will come on Thursday, with Employment data for Q2. Any further clear retreat in Fonterra’s auction prices, early Wednesday morning, would start to generate a bit of discomfort, given the current heights of NZD. Today, expect the ANZ commodity price index to show a further slippage in prices for July.  

Majors
The USD fell sharply on Friday night as markets fretted about the US debt ceiling and poor US data. Measures of risk aversions spiked higher, helping the “safe haven” JPY and CHF perform strongly.

Over the weekend, news wires are reporting that an agreement will be reached in time to avert the Aug 2 deadline. The bipartisan agreement will lift the debt ceiling past the next presidential election and agree an immediate cuts of USD1 trillion. Uncertainty about the outlook for US growth saw equity markets get hit again on Friday night, with the S&P500 index and Euro Stoxx 50 index down 0.7% and 0.8% respectively.

Sentiment in markets was not helped by more weak data out in the US. US GDP for Q2 was a lacklustre 1.3% (1.8% expected) and personal consumption for Q2 only rose 0.1% (0.8% expected). The data combined with the debt ceiling concerns sent the USD index tumbling to 73.70, from 74.20.

With no agreement reached over raising the US debt ceiling, the USD’s “safe haven” status is fading. The USD hit a record low against the CHF of 0.7850 and a 4 month low against the JPY of 76.70. Japanese Finance Minister Noda again warned about the rise in the JPY on Friday, however for now, we do not expect any intervention given its limited chance of success.

EUR/USD surged to above 1.4400 in the early hours of Saturday morning, from below 1.4300. While the issues in Europe still remain, expect the US debt ceiling saga to take centre stage for now.

The CAD tumbled against the USD after weaker-than-expected GDP for May (-0.3% vs 0.1% expected). This saw USD/CAD jump to 0.9590, from 0.9500. The data has seen OIS markets scale back expectation of rate hikes from the Bank of Canada over the next 12 months to 40bps, from 49bps.

Looking to the week ahead, the focus will be on the US debt ceiling saga. We remain hopeful a compromise will be reached at the by the August 2 deadline. It is a busy data week. We get the monthly PMI manufacturing updates for the US, Eurozone, UK and China throughout the week. We also have the important US non-farm payrolls data on Friday evening. We have several central bank interest rate decisions, on Tuesday it’s the RBA decision and then on Thursday we have the BoE and ECB - all are expected to leave rates unchanged.

Fixed Interest Markets

New Zealand swap and bond yields declined following the lead of their Australian counterparts, on Friday. Curves continued to flatten.

Swap yields declined across the curve giving back some of the rise in yield that followed Thursday’s RBNZ statement. 2-year yields declined 4bps to trade at 3.71%, now a little below the 3.80% level they traded at immediately prior to February’s ChCh earthquake.10-year yields fell 6bps to 5.15% resulting in the 2s-10s curve flattening to 144bps, the lowest level since January.

Bond yields also fell after a DMO tender saw strong demand. 753m of bids were received for 250m of bonds on offer. The successful bid for 21s was 5.01%. Yields on 21s declined later in the afternoon to close at 4.93%. This is their lowest level since March 2009, as off-shore concerns continue to weigh on long-end yields.

In the US, over the weekend, the Senate Republican leader said “We’re really, really close to an agreement” on the US debt ceiling.  However, on Friday the ongoing uncertainty saw the VIX index (a proxy for risk aversion) spike to the highest level (25) since the Japanese crisis in March. US bond yields continued to fall as market uncertainty saw investors seeking out “safe haven” US Treasuries. The market is not using the prospect of a US rating downgrade as a catalyst to add risk premium to US bond yields. Rather, on Friday, US 10-year yields declined from 2.95% to 2.80%, their lowest level since November 2010. Yields were also weighed on by the release of US Q2 GDP that showed growth of only 1.3% (1.8% expected).

In Europe, Moody’s placed Spain on negative watch, taking its rating toAa2-. At an Italian auction of 3.9bn of 10-year securities a yield of 5.77% was achieved. The rate at the previous10-year bond sale at the end of June was 4.94%. In later trading Italian and Spanish 10-year yields rose to 5.87% and 6.08% respectively. Their CDS spreads have also spiked higher. Spreads to Bunds widened as German 10-year yields fell from 2.60% to 2.54%.

Australian swap yields also declined on Friday with 3-year swaps declining 10bps. This has taken the NZ-AU 3-year swap spread from -97bps to -90bps. The RBA meeting tomorrow will see the cash rate held at 4.75%, but accompanied by a more hawkish statement, in our view. This should see markets revisit rate expectations, where around 25bps of rate cuts are still priced for the coming year. We do not expect rate cuts. In the near-term this should see NZ-AU swap spreads become more negative.

Despite the meaningful rise in NZ short-end yields seen in recent weeks, they continue to trade below “fair value” that we see at 4.25% and 4.50% for 2 and 3-year swap yields respectively. We therefore sill see value in fixing NZ interest rate protection on a 2-4 year time horizon.

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.