Euro keeps falling on Euro debt worries and NZ$ continues to react to commodity price concerns. NZDMO auction well covered.

After what seemed like a relentless rally, the NZD finally lost some steam last week. The NZD/USD posted its first weekly decline in seven weeks.

In a reversal of recent fortunes, the global backdrop became less NZD friendly last week at the same time as the domestic backdrop provided some support. Thursday’s Q1 NZ labour statistics poured cold water on the idea the NZ economy is teetering. Employment rebounded and the unemployment rate dropped to 6.6%. Against a background of falling global interest rates, the data helped shore up the NZD’s yield advantage. NZ-US 3-year swap differentials rose 5bps over the week to 263bps.

Nevertheless, a collapse in global commodity prices and a broad-based strengthening in the USD conspired to knock the NZD/USD lower. From around 0.8100 at the start of the week, the NZD/USD fell steadily to around 0.7850, before recovering slightly on Friday.

It’s hard to pinpoint the exact trigger for the commodities slide but worries about the growth impact of Chinese policy tightening, a change in margin requirements for silver trading on the CME and speculative froth all likely contributed. Oil prices tumbled nearly 15% over the week, silver prices plummeted 26%, and the broader CRB index ended the week down 9%.

The associated paring of investors’ risk appetite provided support to “safe-haven” currencies like the JPY and USD. However, the EUR bore most of the brunt of the stronger USD, after ECB officials appeared to adopt a less hawkish stance at Thursday’s policy meeting. NZD/EUR leapt from 0.5300 to 0.5500.

Looking ahead, it is a relatively unexciting week for NZ data and events. As such, offshore developments should again dictate NZD direction this week. In particular, keep an eye on this week’s slew of Chinese data. A strong set of figures would act to limit further declines in commodity prices and by association, the NZD and AUD. In addition, developments in European debt markets will be worth watching for clues on whether last week’s EUR sell-off was a flash in the pan, or the beginnings of something more sinister.

All up, we suspect the NZD/USD is in for a choppy range-bound week. Near-term support is eyed towards 0.7740 with stiff headwinds expected on rallies towards last week’s 0.8120 high.

Majors

The USD strengthened noticeably on Friday, buoyed by upbeat US employment figures and a bout of heavy EUR selling.

According to Friday’s non-farm payrolls report, US employers added a whopping 244k jobs in April, easily outstripping the 185k analysts forecast. Admittedly, an unexpected rise in the unemployment rate (to 9.0%, from 8.8%) tempered the extent of markets’ cheery response. US Treasury yields pushed higher, equity markets rallied (the S&P500 ended the night up 0.4%) and the USD started the night on the front foot.

“Risk-sensitive” assets like commodity prices, the AUD and the CAD revelled in the more optimistic global growth sentiment. Oil prices climbed from $100/barrel to around US$102, and the AUD/USD briefly flirted with 1.0800.

However, later in the night, investors’ pared back their risk appetite as Eurozone debt worries returned to the fore. In particular, Der Spiegel reported Greece was considering leaving the Eurozone. In response, stocks and commodity prices reversed part of their earlier gains and a heavy toll was taken on the EUR. From around 1.4550, EUR/USD skidded to around 1.4340 with weakness evident amongst all the EUR crosses. Reports that German Chancellor Merkel will oppose Draghi's candidacy to lead the ECB probably didn’t help EUR sentiment.

The USD is now some 3% above its 72.70 lows. Key to the fortunes of the USD going forward is whether last week’s EUR/USD sell-off was simply a bout of profit-taking driven by the heavily long speculative community or the beginnings of a deeper correction. If European debt jitters continue to take hold this week, the scales would be tipped in favour of the latter.

Fixed Interest Markets

NZ bond yields declined a little further on Friday, completing a 20bp fall in 21s yield last week. Curves flattened. 10 year EFP has moved back close to zero.

Friday saw another extremely well bid Debt Management Office (DMO) auction with close to 3.2b bids for $400m on offer. The yield on 17s to 21s ticked down by around another 4bp on Friday, taking 21s yields back to around 5.24%, levels last seen in October 2010. A 25bp fall in 19s yield last week took it back to around 5.05%.

Yields appear to be being driven lower by a combination of factors. First, continued strong demand relative to the finite supply that the DMO has announced will be available over the next couple of months. Second, long bond yields are moving in line with their strong correlation with US bond yields, as global risk aversion rises, and “safe haven” assets such as US 10 year bonds are bought.

After Friday’s RBA minutes that were taken to be relatively hawkish, Australian swap yields rose with 3 year yields rising from around 5.28% to 5.38%. Consequently, the NZ/AU swap spread became more negative, moving from around -1.47% to -1.54%.

In the week ahead, local highlights will be the RBNZ Financial Stability Report on Wednesday while Thursday’s PMI and April’s Food Price Index will provide further colour on the inflation outlook. Global risk appetite and the DMO auction are also likely to continue to be key drivers of NZ interest rate markets this week.

Mike Jones is part of the BNZ research team. 

All its research is available here.