Despite disappointing retail sales, the NZD may not weaken further as it is bolstered by strong terms of trade. Italy toys with issuing parallel currency, worrying its EU partners

By Jason Wong

In an uneventful start to the week, commodity currencies have modestly outperformed following the weekend news of a truce in the US-China trade war.  UST10 yields have sustained their move lower seen at the end of last week.

There’s a risk-on vibe to markets, after the joint US-China statement over the weekend and Mnuchin’s comments that any proposed tariffs would be put on ice while trade negotiations continue. 

As we reported yesterday, while there was a lack of specific numerical targets in the statement, “both sides agreed on meaningful increases in US agriculture and energy exports”.  President Trump has been out tweeting again, this time talking up the positive vibe on US-China trade negotiations including “China has agreed to buy massive amounts of ADDITIONAL Farm/Agricultural Products – would be one of the best things to happen to our farmers in many years!”.  On this theme, there is a lot of water to go under the bridge yet, especially on the thorny issue of protecting US intellectual property, the area that kicked off the trade tensions in the first place.  For now, the market is prepared to accept the positive spin and the lack of any immediate threats to global trade.

Global equity markets are higher, with the S&P500 currently up 0.6% and the VIX index lower.  The AUD, the biggest beneficiary of reduced risk around China trade frictions, has been the best performing of the majors, up 0.7% to 0.7570, an area which it has struggled to sustainably move up through over the past few weeks.

The NZD, at 0.6930, has lagged the move higher in commodity currencies and is only a touch higher from last week’s close, while NZD/AUD has slipped a little to 0.9150.  Disappointing Q1 retail sales data yesterday didn’t help sentiment as the data aligns with other partial indicators that suggest GDP growth momentum was weak in the March quarter, the first one since the new government was formed.  However, we’re not reading too much into the weak result, with the growth outlook still looking fine.  Easier fiscal policy is equivalent to around 1% of GDP over the coming year and the combination of rising dairy prices and the weaker NZD mean that the expected milk payout for dairy farmers for FY19 has improved by 15% this year, based on pricing in the futures market – so that’s more than $1b extra for dairy farmers compared to expectations at the beginning of the year. Yesterday we published a note on the NZD suggesting that the currency has seen enough weakness for now.  After its recent plunge, any further fall would be against fundamental value which sits closer to the 0.72 mark.  While lower NZ-US rates represent an ongoing headwind, strong NZ terms of trade represent a nice tailwind.  Speculative positioning is now closer to neutral after being excessively long in mid-April.

The USD was broadly stronger during the Asian trading session with the index up 0.4% but a clear turnaround was evident from the start of London trading and it is now flat for the day.  At the height of USD strength, EUR got down to a fresh low of 1.1717, but it has since recovered to 1.1770.  The backdrop remains one of concern about the new populist Italian government, with Italy’s 10-year year rate piling on another 15bps to 2.37%.  To pay for the increase in fiscal profligacy, attention has turned to previous propositions to issue “mini-BOTs” – short-term notes that can serve as a parallel currency, avoiding the stringent rules that membership of the euro-area monetary system entails.  That would be a dangerous path for Italy to go down, and the tail-risk of this scenario is enough to overhang the Italian bond market and EUR for now.

GBP moved down to a fresh low for the year, just under 1.34, and it hasn’t managed to recover much even as the USD turned weaker. Brexit negotiations resume in Brussels this week, with the Irish border the most important issue to be resolved before the next EU summit in June.  Against a positive risk backdrop JPY is also on the weak side, with USD/JPY sustaining a move into 111 territory.

UST10 yields have traded in a narrow 3.06-3.08% range, sustaining the move lower on Friday night.  The relative stability in US rates has come despite further safe-haven flows (out of Italy) into Germany, which has seen 10-year bunds down 6bps to 0.52%.   Fed speakers Bostic and Harker have been giving speeches and haven’t added much to the body of knowledge.  There was downward pressure on the NZ rates curve yesterday as it responded to the lower US rates of Friday night.  The swaps curve flattened, with the 2-year rate down 2bps to 2.215% and the 10-year rate down 5bps to 3.23%.  The economic calendar for the next 24 hours is completely barren.

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