Volatility on currency markets spikes as NZ dollar was world's 2nd weakest currency last week behind Aussie dollar
21st Mar 11, 9:41am
by
By Mike Jones
Global growth sensitive currencies like the NZD underperformed last week. With the exception of the AUD, the NZD weakened against all the major currencies.
Global growth worries flared up last week. Not only did Japan’s escalating nuclear crisis send shockwaves through global markets, but political tensions in the Middle East showed no sign of abating. Indicative of soaring global risk aversion, the MSCI World Equity Index slid 2.1% over the week and our risk appetite index (which has a scale of 0-100%) dived to an 8-month low of 41.2%.
Against a backdrop of equity market weakness and subdued risk appetite, investors shunned “risk-sensitive” currencies like the NZD and AUD in favour of the relative “safe-haven” of the USD, CHF and JPY. By the middle of the week, the NZD/USD had fallen to 6-month lows below 0.7150 while NZD/JPY had skidded to a 23-month low of almost 55.00.
On Friday, selling pressure on the NZD evaporated. Not only did a modest recovery in risk appetite bolster demand for the NZD, but NZD/JPY marched higher following coordinated intervention from the G7 to lower the JPY. As a result, the NZD/USD and NZD/JPY ended the week well off their lows around 0.7300 and 59.00 respectively.
It’s worth noting, currency volatility increased markedly last week as investors became more risk averse and the global outlook became more uncertain. One-month implied volatility (traded in the options market) on NZD/USD and NZD/JPY spiked to 4-month and 8-month highs respectively. Encouragingly, this has not yet led to a noticeable widening in bid-ask spreads. Last week’s average bid-ask spread in NZD/USD of 5bps was only marginally above the average for the year of 4bps.
Looking ahead, we suspect trends in global risk appetite will remain the dominant driver of the NZD/USD this week. As ever, developments in Japan and the Middle East will be important to watch in this regard.
However, a couple of big data releases should ensure the NZD receives some local direction as well. Most notably, we have settled on 0.2% for Thursday’s Q4 GDP number (in line with market expectations). Meanwhile, the good news on NZ’s external position looks set to continue on Wednesday with a narrowing in NZ’s current account deficit, to 2.3% of GDP, expected for Q2 (from 3.1% in Q3).
All up, we doubt we’ll see a sustained break of last week’s 0.7120 low in the NZD/USD this week, absent another melt-down in global stock markets. Still, our short-term valuation model suggests the balance of risks are still tilted towards the downside. The model currently estimates a NZD/USD “fair-value” range of 0.7050-0.7250.
Majors
A modest recovery in risk appetite saw “safe-haven” currencies such as the USD, CHF and JPY lose ground on Friday.
News a ceasefire had been announced in Libya, combined with an easing in fears about Japan’s nuclear crisis (reports suggested power had been connected to the stricken Fukushima nuclear plant), saw investors become slightly less risk averse. Indicative of such, global equity indices posted gains of 0.1-0.7% and the VIX index (a proxy for risk aversion) fell back to 24%, from above 27% on Thursday, and as high as 31% earlier in the week.
Against this backdrop, investors trimmed positions in “safe-haven” currencies like the JPY, CHF and USD in favour of higher yielding currencies like EUR, NZD and AUD. As a result, the EUR/USD climbed from 1.4050 to 4-month highs of nearly 1.4180 and the AUD/USD recovered to 0.9950, from around 0.9800 at the start of the night.
Still, most of the action was in JPY. On Friday afternoon, the G7 staged a coordinated intervention to lower the JPY, the first such joint action since 2000. The move was in response to worries the strengthening JPY could dent Japanese exports and throw Japan back into recession, slowing global growth.
Traders estimated the Bank of Japan alone sold about $25b worth of JPY, with the US Federal Reserve, Bank of England, Bank of Canada and ECB all separately confirming intervention.
The knee-jerk response saw USD/JPY surge from 79.00 to above 81.00 with similar weakness evident amongst the JPY crosses. EUR/JPY leapt from 111 to above 114 and GBP/JPY climbed from 128 to almost 132. Part of the JPY’s intervention losses were unwound of Friday night, but with Japanese officials warning the G7 is ready to “act decisively” again to prevent JPY strength, investors are likely to remain wary of pushing the JPY up too far this week.
With all eyes on the BoJ and the JPY, there was almost no reaction to China’s decision to hike banks’ reserve requirements 50bps (to a record 20%) on Friday.
Looking ahead, event risk for currency markets will come from familiar sources this week. In particular, Japan’s nuclear crisis and the possibility of further BoJ intervention will remain in focus, as will the general unrest in Libya and Middle East more generally (the weekend’s news suggests Gaddafi’s forces have broken the cease fire).
The effects of such on investors’ general risk appetite should dictate currency market sentiment this week. Data-wise the calendar is fairly light.
Mike Jones is part of the BNZ research team.
All its research is available here.
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