Markets wait to see if RBNZ statement contains clue as to pace of interest rate rises.

By Mike Jones,  Mike Burrowes and Kymberly Martin

The NZD/USD has backed off from levels close to its post-float high, as a bout of risk aversion prompted “safe-haven” buying of USD, CHF and JPY overnight.  

Most of the NZD’s losses occurred during the Asian session as market participants focused on a bearish article in the Wall Street Journal noting the AUD is “running out of rocket fuel”. As risk sentiment soured markets latched onto another bearish article titled “China’s coming collapse”. Unsurprisingly it was AUD that lead the charge lower amongst the majors and it has continued to underperform during the overnight session. AUD/USD is currently down around 1% to be trading around 1.0610.

The NZD/USD moved in sympathy with the AUD down to the 0.8150 level yesterday afternoon but since then the NZD has remained firmly on the sidelines in overnight trading. Some real money and hedging activity were noted amongst the flows in the NZD over the past 24 hours.

NZD/AUD managed to pop briefly above the 0.7700 level as AUD/USD gapped lower yesterday with short-term leveraged accounts active buyers on the day. The RBNZ decision this morning will be pivotal in providing near-term direction for the cross.    

Today’s RBNZ OCR decision at 9am will set the tone for the NZD in the coming session. We suspect it will be a much firmer document than the earthquake-rattled MPS of March, given the increasing signs of strong GDP growth in the pipeline and, more to the point, inflation headaches in the making.

On balance we think the Bank will signal a late-2011 start to its tightening cycle, similar to that inferred from the March MPS. Any hint from the RBNZ that the tightening cycle could begin earlier than the early 2012 start markets expect would provide more legs for the NZD/USD. A more upbeat statement could see NZD/USD challenge the post-float high around 0.8260. Expect support on NZD/USD around 0.8100 to 0.8075.

Majors

A mild bout of risk aversion saw “safe-haven” currencies like the USD, JPY and CHF outperform overnight.

US Federal Reserve chairman Bernanke yesterday acknowledged the recent slowing in the US economy, noting “accommodative monetary policies are still needed.” However Bernanke dashed any hopes further monetary stimulus (so called QEIII) was likely, putting something of dampener on market sentiment.

Uninspiring economic data added to the more sombre mood. April German industrial production figures recorded a 0.6%m/m decline, in stark contrast to expectations for a 0.2% monthly gain.

Lingering global growth worries saw global stock markets post a sixth-straight daily decline. European equity indices slipped 0.6-1.0% and the S&P500 is currently down around 0.2%. The VIX index (a proxy for risk aversion) ticked up from 18% to around 18.4%.

Against a backdrop of weak equities and rising risk aversion, investors culled positions in “growth-sensitive” currencies in favour of the relative “safe-haven” of the CHF, JPY and USD.

The EUR tended to suffer more than most, thanks to yet another bout of Greek default jitters. German finance Minister Schäuble said policy makers “face the real risk of the first unorderly default within the Eurozone” should the Eurozone fail to reach agreement on how to best support Greece. European sovereign credit spreads widened by 7-20bps and the EUR/USD skidded from 1.4680 to around 1.4580.

The GBP suffered after ratings agency Moody’s warning that “slower growth combined with weaker-than-expected fiscal consolidation efforts” could see the UK  lose its AAA rating. Still, after plunging around ½ cent to 1.6360 in the immediate aftermath, the GBP/USD spent the rest of the night paring these losses.

Looking ahead, tonight’s ECB and Bank of England interest rate decisions will occupy markets’ focus in the short-term. In particular, investors will be looking for signals from ECB head Trichet about the possibility of a July rate hike. According to OIS pricing, some 80 bps of ECB tightening is expected over the next 12 months. Disappointment from Trichet on the chances of a near-term hike would be consistent with a EUR/USD pullback towards 1.4500.

Fixed Interest Markets

The NZ market was relatively steady ahead of the RBNZ meeting today. Key global long yields declined as expectations for global growth were again tested.

Within NZ government bonds, the largest decline in yield was seen in 13s which fell by around 4bps to 3.19%. The yield on 21s remains just above 5.1%, not far off recent lows. They continue to be weighed on by falling US Treasury yields.

Overnight US 10-year yields declined from around 3.0% back to last week’s lows of 2.94%, their lowest levels this year. Fed chairman Bernanke yesterday commented that monetary stimulus was still needed to bolster demand, with reference to a recent array of weaker-than-expected US data. German bund yields also fell from 3.08% to 3.05% reflecting the disappointing April German industrial production data mentioned above.

In NZ swaps markets, the 10-year yield also remained quite well anchored around 5.21% along with 2-year swap yields around 3.39%. 2-year swaps remain at levels they reached immediately after the February 22 earthquake, just prior to the RBNZ cutting the OCR by 50bps.

The market is looking for the RBNZ to remove most of that 50bp cut over the next 12 months, according to our OIS model. We continue to expect that once the RBNZ gets underway, it will steadily move the OCR to be 100bp higher in a year’s time.

We therefore believe, that short-end swap rates could move abruptly higher when sentiment toward the OCR being ‘low for longer’ begins to change. Today’s RBNZ statement will be important in this regard. We expect that this meeting’s statement will be more balanced than the earthquake-dominated March MPS statement, given recent robustness in growth and inflation expectations data.

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

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

All its research is available here.