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Spanish debt worries whip markets into a frenzy; NZ$/US$ trades below 80 cents

Currencies
Spanish debt worries whip markets into a frenzy; NZ$/US$ trades below 80 cents

by Mike Jones

NZD

After spending most of last week edging higher, the NZD rally was scuppered on Friday. From above 0.8030, the NZD/USD slipped back below 0.8000 as Spanish debt worries whipped markets into a frenzy.

As the European rot spreads, markets are now beginning to wonder if the Spanish sovereign will soon follow its banks and ask for a bailout.

Meanwhile, soaring government borrowing costs are starting to spill over from Spain to Italy, reigniting contagion fears. All of this is occurring against a backdrop of slowing global growth.

On Friday, worries about a Europe-led global slowdown took a clear toll on equity and commodity markets. Our risk appetite index eased from 67% to 64.3%. The associated flight to ‘safe-haven’ assets saw the NZD/USD pull-back below 0.8000.

Still, a couple of factors helped prop up the currency. First, more NZD/EUR buying. Indeed, the cross hit another all-time high above 0.6580 on Friday. Second, widening interest rate differentials.

Falling global yields, against steady local interest rates, are boosting the relative yield appeal of the NZD.

We suspect both of these factors are likely to continue to support NZD demand in the short-term, even in the face of a deteriorating global backdrop. This should limit NZD/USD dips to 0.7850 this week.

This week’s RBNZ OCR review will be important in thinking about where NZD interest rate differentials may head from here. We expect the RBNZ to issue a commentary broadly maintaining the tones of the June MPS.

The economy still looks to be progressing relatively well (on top of Q1 GDP proving about 1% stronger than the RBNZ anticipated), capacity constraints are threatening and the housing market is heating up again.

However, headline CPI inflation is restrained, the currency is higher than the RBNZ expected, and global risks are ever present. Expect the Bank to signal a 2.50% OCR for the foreseeable future.

Along with the RBNZ meeting, Wednesday’s Australian CPI will ensure it’s a busy week for the NZD/AUD. We look for NZD/AUD support at 0.7680 to hold. Relative interest rate differentials still suggest a push higher is likely. This week’s event risk will provide a cross check on this.
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Majors

The uneasy European calm was shattered on Friday night. Spain burst back into the headlines for all the wrong reasons, undermining risk sentiment and boosting demand for the relative ‘safe-haven’ of the USD and JPY.

Equity markets were slammed, commodity prices fell, and bond yields mostly declined.

Rumours the German political opposition were backing a Greek exit from the EMU weighed on risk sentiment, as did spiralling Spanish borrowing costs. The 10-year Spanish bond yield hit a EU-era high of 7.27%, with the spread to German bunds climbing to 600bps.

Risk-sensitive currencies struggled in this backdrop. However, the EUR was again the whipping boy, continuing the theme of last week. In fact, the EUR/USD slumped to fresh 2-year lows below 1.2150.

Heavy selling of EUR crosses (CAD, AUD, JPY, SEK) saw many hit multi-year or all-time lows.

Rattling confidence on Friday was news the Valencia Region of Spain had applied for a bailout. Weekend reports from Spanish newspaper El Pais suggest another six regions (including Catalonia) will soon do the same.

This, and ongoing uncertainty about how the European bailout funds will be used to recapitalise Spanish banks, should keep the downward pressure on the EUR this week. EUR/USD bounces towards 1.2250 should be met with selling pressure. There is little support ahead of the 2010 1.1880 lows.

Along with European headlines, there is also a raft of important data out this week that will help shape sentiment towards the global economy and appetite for risk. The Flash Eurozone PMIs should show the manufacturing sector remaining in contraction, but perhaps with some signs of a bottoming.

We look for a below consensus 45.0 reading for Germany. There also looks to be downside risk on the consensus forecast (104.7) for the German IFO (Wed).

Elsewhere, the preliminary Q2 GDP readings for the US and UK will get plenty of focus. We expect a flat outturn for the UK, below the 0.2%q/q expected by the market. For the US, a weaker result than the 1.4% (q/q annualised) expected would no doubt reawaken hopes of additional Fed easing. Such an outcome would provide headwinds for the USD, offsetting some of the ‘safe-haven’ allure it currently enjoys.

Other news: UK public borrowing falls to £12.1b in June, slightly worse than expectations (of £11.2b). *Rating agency Egan Jones cuts Spain’s sovereign rating to CC+ from CCC+. *A PBOC official says Chinese growth may slide to 7.4%y/y this quarter, and that a short period of deflation can’t be ruled out.

Event Calendar:
23 July: AU PPIs; US Chicago Fed index; 24 July: CH HSBC manufacturing PMI; AU RBA’s Stevens speaks; EU manufacturing/services PMIs; US Richmond Fed index; US house prices; 25 July: NZ trade balance; AU CPI; EU German IFO; UK Q2 GDP; US new home sales; 26 July: NZ RBNZ OCR review; NZ finance minister speaking; US durable goods orders; US jobless claims; US pending home sales; 27 July: EU German CPI; US Q2 GDP; US Michigan consumer confidence.
 

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