Election uncertainty weighs on Aussie dollar

By Mike Jones

In what has been a relatively uneventful 24 hours in currency markets, the NZD/USD stands out as the strongest performing currency amongst the majors. There wasn’t a lot of action in currency markets overnight. Given the renewed uncertainty over the global economic outlook, markets are awaiting further news on this front to provide direction.

Nevertheless, the NZD/USD managed to find plenty of support. Most notably, a surge in NZD/AUD provided clear tailwinds for the NZD/USD overnight.

Uncertainty about the upcoming Australian election has begun to weigh on the AUD, particularly in regards to possible changes to the Australian resources tax and the introduction of austerity measures. At the same time, NZ-AU 3-year swap spreads have become less negative. After hitting 15-year lows of around -95bps earlier in the week, spreads have increased to around -82bps over the past 24 hours.

The reduced yield drag prompted a sharp unwinding of speculative investors’ NZD/AUD short positions, propelling the cross from 0.7860 to around 0.7960 overnight.

Along with the strengthening NZD/AUD, rumoured NZD demand from sovereign and quasi-sovereign accounts also underpinned the currency overnight. As a result, NZD/USD was pitched from 0.7120 to an overnight high of almost 0.7190.

We noted yesterday that the NZD/USD’s repeated failure to breach support around the 0.7050/60 region means the recent NZD/USD downtrend has probably run its course for now.

However, we suspect signs of fading NZ economic momentum and reduced yield support will limit NZD/USD bounces to the 0.7250 region in the near-term. Our short-term valuation model currently suggests a NZD/USD “fair-value” range of 0.7050-0.7250.

Majors

Currency markets struggled for direction overnight. There was little fresh economic news to cast light on the global outlook and equity markets were generally mixed.

As a result, the USD spent most of the night shuffling sideways. Early in the night, a further thawing in European sovereign debt concerns provided a boost to the EUR. A €5b sale of German 10-year bonds produced a record-low yield of 2.37%. Portugal also ran a fairly successfully T-bill auction. European sovereign credit spreads mostly eased and EUR/USD climbed to an overnight high a smidge above 1.2900.

However, resistance around 1.2920 once again proved too great a hurdle for EUR/USD, and the single currency eventually settled back below 1.2900. USD/JPY continues to closely track US-JP interest rate differentials. A modest decline in US bond yields overnight (10-year yields slipped 3bps) saw USD/JPY inch down to 85.20. Growing speculation that Japanese authorities are only likely to intervene to quell a rapid appreciation in the JPY should keep USD/JPY under pressure in coming sessions.

The Bank of England’s August MPC minutes were not quite as dovish as expected, lighting a rocket under the GBP. Earlier speculation the BoE was considering extending its quantitative easing scheme was dashed. The MPC voted 8-1 in favour of keeping interest rates and asset-purchases on hold with the Committee’s lone hawk Sentence again voting for a rate rise. In the wake of the minutes release, GBP/USD surged from 1.5520 to almost 1.5690.

While equity markets put in a mixed performance overnight, a further mild improvement in investors’ risk appetite was evident from a third consecutive day of gains in US stocks.

The S&P500 rose just under 0.5% and the VIX index (a risk aversion proxy) slid from 25% to almost 23.5%. As a result, growth-sensitive or “risky” currencies were generally the biggest winners of the night. Most notably, USD/CAD dribbled off from 1.0330 to almost 1.0270 with the afterglow from yesterday’s US$38.6b BHP Billiton bid for Canadian firm Potash Corp also adding support.

Looking ahead, currency markets have been skittish and fickle of late as investors’ outlook for the global economy has swung between optimism and pessimism. Further clues on the global outlook will come from tonight’s UK retail sales and public finances data, the US Philadelphia Fed index, and a speech on the US economy from St. Louis Fed President Bullard.

* Mike Jones is part of the BNZ research team. 

All its research is available here.