NZ$ near 3 year TWI highs on NZ$/A$ strength, offsetting low interest rates.

By Mike Jones and Kymberly Martin

It’s been a choppy 24 hours for the NZD/USD, albeit within familiar ranges. Oscillating risk appetite, driven by uncertainty over the Greek debt crisis, spurred renewed volatility in currency markets. After sliding to around 0.7900 yesterday evening, the NZD/USD has rebounded to around 0.8000 this morning.

Still, the NZD finished the night near the top of the global currency performance rankings. It seems the currency continues to bathe in the afterglow of the recent spate of more positive NZ economic news.

In fact, on a trade-weighted basis, the NZD hit the highest level in almost 3-years. Until now the weak NZD/AUD has been holding back the TWI to some extent. But with the NZD/AUD having climbed some 2.9% in May to date, the TWI is now closing in on 70.00 for the first time since June 2008. Overnight, Australian commentator Terry McCrann said Europe’s debt crisis will adversely affect Australia, propelling NZD/AUD to 3-month highs above 0.7580.

So is the recent currency strength a threat to the NZ recovery?  In this regard, it’s worth considering a broader indicator of financial conditions, given the NZD and interest rates are working in opposite directions in terms of their respective restraining/supporting effects on the economy.

A simple 2:1 monetary conditions index shows that conditions now are about as tight as prior to the devastating February 22nd Christchurch earthquake and subsequent 50bps RBNZ rate cut. In other words, the soaring TWI has more than offset the RBNZ’s attempt to ease financial conditions.

Moreover, assuming the currency does not fall out of bed in the short-term, there is little chance of the RBNZ’s (implied) monetary conditions forecasts from the March MPS being fulfilled. As such, tighter financial conditions are one obvious economic negative the Bank will have to balance against a series of positives as it puts together its forecasts for the June MPS.

Looking ahead, there is no key local data to watch for today. But keep an eye on a speech from RBA deputy governor Battelino across the Tasman. The NZD/USD continues to encounter headwinds on bounces towards 0.8020. A daily close above this level would bring a test of the recent 0.8120 high into focus.

Majors

It’s been a volatile 24 hours in currency markets with the major currencies putting in a generally mixed performance. Sentiment and risk appetite has generally waxed and waned in line with the twists and turns of the European sovereign debt crisis.

Through Asian and early London trading the USD strengthened relative to most of the majors as more negative Greek news knocked investors’ risk appetite. A Wall Street Journal article highlighted European divisions over how to deal with Greece and the OECD warned debt levels in Greece, Ireland and Portugal were unsustainable.

Asian equity markets suffered through another dour day, further pressuring investor confidence. The Shanghai composite index slipped 0.9% to be down over 10% from April’s highs.  In response the EUR/USD skidded from 1.4100 to around 1.4020, dragging most of the majors lower in sympathy.

However risk appetite and the EUR/USD stabilised through the New York session, causing the USD to reverse most of its earlier gains.

Finland’s approval of participation in the Portuguese bailout, hawkish comments from ECB member Stark and an on-expectation Q1 UK GDP number (0.5%q/q) all likely contributed to the improvement in mood. Global stock markets recorded small gains and the VIX index (a proxy for risk aversion) dipped from 18.0 to around 17.2.

Not only did easing risk aversion weigh on the USD but Apirl durable goods orders data wasn’t particularly inspiring (-3.6%m/m vs. -2.5% expected) and US Treasury Secretary Geither said US unemployment will come down “too slowly for everybody”.

Against the retreating USD, the EUR/USD bounced back to around 1.4080. Meanwhile the GBP/USD surged from 1.6140 to almost 1.6280 reflecting widespread relief UK GDP figures weren’t any worse.

Fixed Interest Markets

NZ curves flattened as long-end yields inched lower while short-end yields moved a little higher.

The DMO announced its tender for the week with $100m each of 13s,17s and 19s. The tender offer is lower than in recent weeks. This is likely in response to the dip in demand seen at last week’s tender which itself may be a response to the recent rally in long bonds that has made yields less attractive.

Yesterday 17s to 21s yields fell by 2-4bp while 13s and 15s rose by 3-4bp resulting in some flattening in the curve. A similar dynamic was seen at play in the swap curve with 2s-10s flattening from 185bp to 181bp.

However, given the bump higher in short-end yields seen on Tuesday, post the high-side surprise on inflation expectations, the spread between NZ and Australian short-end swaps has become less negative. The NZ-AU 3-year swap spread has moved from -1.58% this time last week, to around -1.46%.

The downward pressure on US long yields will likely hold back any attempt by NZ long yields to rise today. The key local development will be the DMO auction where demand is expected to be solid rather than excessive.

See our interactive swap rates charts here and bond rate charts here.

Mike Jones and Kymberly Martin are part of the BNZ research team. 

All its research is available here.