Risk aversion takes hold as Portugal goes to "junk" and worries about Chinese growth and debt surface

By Mike Burrowes and Kymberly Martin

The NZD submitted to rising risk aversion over the past 24 hours. After NZD/USD made new post-float highs around 0.8330 in thin trading yesterday morning, we have fallen all the way back to 0.8250 currently. Despite the falls, the NZD has been better supported than most of the other major currencies.

Despite the positive data outturns on both sides of the Tasman, risk-sentiment was hit by headlines suggesting China will tighten policy over the weekend and Moody’s warned about local government debts in China. This pushed NZD/USD off its post-float highs down to around 0.8260.

The Quarterly Survey of Business Opinion (QSBO) was solid enough and consistent with our view of a firm NZ economic recovery. The rebound in confidence was particularly encouraging, given part of the reason the RBNZ put its “insurance cut” of 50bps in place was fear of a sustained collapse in confidence. This clearly hasn’t happened. Therefore, one has to question the need to persist with the super-precautionary element of the present record low OCR of 2.50%. It now presents inflation risks and threatens to stifle rebalancing.

The RBA left rates unchanged at 4.75%, as widely expected. However, there were distinct hints the RBA lowered its forecasts for Australian growth and inflation. It was also more open to the possibility that the world economic slowdown could have more legs to it. The dovish accompanying statement saw AUD/USD shed almost a cent down to 1.0660. AUD/USD has spent the rest of the evening chopping between 1.0670 and 1.0710.

It has been a volatile 24 hours for NZD/AUD. During the day, the cross rallied from 0.7720 to above 0.7750. But these gains have been fully reversed early this morning as the NZD was harder hit by the rising USD. The weak EUR has seen NZD/EUR rally from 0.5700 to 0.5730 currently.

Further pressuring the NZD lower overnight was a 6.7% decline in global dairy prices at Fonterra’s latest auction. This result is not completely unexpected, given the recent declines in other soft commodity prices. Global dairy prices still remain 17.5% higher than this time last year.

Looking to the day ahead, there is no data out in NZ. For the day, initial support on NZD/USD is seen at 0.8210 and resistance at 0.8300.   

Majors

The USD strengthened over the past 24 hours, supported by a bout of risk aversion. Once again, EUR/USD lead the declines after Moody’s slashed Portugal’s credit rating four notches to ‘junk status’. This highlights concerns regarding the risk of contagion from events in Greece. Yesterday’s comments from S&P that the plan to rollover Greece’s debt would be deemed ‘selective default’ also continued weigh on sentiment.

The rally in the USD started yesterday with a mix of headlines that all weighed on risk sentiment (see above). The negative sentiment continued into the evening with the release of weaker-than-expected Eurozone PMI services for June (53.7 vs 54.2 expected) and retail sales for May (-1.1% vs -1%m/m expected). The negative news saw EUR/USD fall from around 1.4540 to 1.4440. The other major currencies were also dragged lower.

The EUR has continued to fall late this morning after Moody’s slashed Portugal's credit rating by four notches to “junk status” (Ba2). Moody’s noted that Portugal faces significant challenges to implementing its austerity measures and will likely need a second bailout package. Since the headlines, EUR/USD has collapsed from 1.4480 to around 1.4420 currently.

Despite the negative developments in the Eurozone, the services PMI for June was better-than-expected (53.8 vs 53.5 expected). The data boosted GBP/USD from around 1.6020 to 1.6100, but the strengthening USD throughout the rest of the night has seen the gains pared back.

The Swedish Riksbank raised its policy rate by 25bps to 2% overnight. While the move was widely expected, the accompanying statement was more hawkish. The more hawkish statement provided some decent support to SEK relative to the USD, ending the night unchanged despite a stronger USD.

Looking to the night ahead, the only data out in Europe is German factory orders. Expect the focus to remain on the European debt crisis. In the US, markets will focus on the ISM non-manufacturing and MBA mortgage applications.

Fixed Interest Markets

NZ swaps and bonds finished the day virtually unchanged, although with some relatively sharp moves intraday. Offshore yields pulled back after their recent ascent.

NZ swaps and bonds initially sold-off yesterday morning after the release of a solid QSBO report. Swap yields rose around 3bps on the data, before falling back over the course of the day. 2-year yields closed at 3.40% and 10-year yields at 5.24%.

Overnight, US 10-year yields topped out after their recent surge higher, as rating agency Moody’s suggested that local Chinese government debt was likely understated, by about a third. This raised some concerns about the robustness of the world’s second largest economy. In addition, US 10-year yields declined early this morning after news that Moody’s had downgraded Portugal’s sovereign rating. Overall, US Treasuries pulled back from 3.18% to 3.12%.

In the US, the debate surrounding the US debt ceiling also continued overnight with Republicans refusing to include ‘tax increases’ as part of any agreement. However, debate was intense as there is no agreed definition of what constitutes a ‘tax increase’. Still some agreement, even if short-term, is expected before the Aug 2 deadline.

Turning to local credit markets, Fonterra’s issue this week of A$300m 5-year notes were priced at 100bp over swap. This is lower than recent borrowing costs for Australia’s highest rating banks. It illustrates the current thirst for bonds outside of the financial industry that is apparent on both sides of the Tasman, due to limited issuance.

It is a quiet day on the data front today, although markets may suffer some decline in risk appetite due to the Moody’s announcement on Portugal, early this morning.

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

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

All its research is available here.