The NZD has outperformed again on Friday night, helped by rising commodity prices and a weak USD. NZD/USD traded to a low of 0.8380 during the early evening, before surging back to above 0.8450 after the release of the European bank stress tests (see below).
The NZD outperformed on the crosses over Friday evening, with the trade-weighted index now above 73.00. NZD/AUD was the stand-out performer, rising from 0.7850 to a high of 0.7950. The move higher in the cross was supported by a sharp narrowing in the 3-year NZ-AU interest rate differentials from -1.43% at the beginning of the week to -1.10% currently. NZD/EUR has traded up from 0.5950 to 0.5980, its highest level since December 2005. NZD/GBP has remained above the 0.5200 level.
NZD/USD remains well supported by interest rate differentials. The 3-year NZ-US interest rate differential has widened from 2.79% at the beginning of the week to 2.85% currently. Despite the move in interest rate differentials, our estimated NZD/USD “fair value” has fallen sightly as risk appetite has fallen. The “fair value” range has fallen ½ cent since last week to 0.7200 to 0.7400. The NZD/AUD “fair value” range has continued to march higher with the move in spot, rising 1 ½ cents over the week to 0.7600 to 0.7800.
Looking to the week ahead, the data schedule kicks off today with Q2 CPI. We and the market are expecting 0.8% q/q. Other key NZ releases this week will be today’s NZ PSI, and Thursday’s migration and credit card spending data. Any further retreat in Wednesday morning’s Fonterra’s auction prices might start to mean something.
Majors
The USD spent Friday evening torn between ongoing concerns around the European debt crisis and worries the US Congress will not reach an agreement to raise the debt ceiling. Overall the USD index is marginally lower, while the commodity sensitive CAD and NZD outperformed.
Concerns around the European debt crisis eased early Saturday morning after results from the European bank stress tests. The test showed only eight banks have insufficient capital to withstand a prolonged recession, less than the 15 banks widely expected. This helped EUR/USD bounce around a cent to above 1.4190, currently trading around 1.4150.
The European debt crisis is likely to remain centre stage, with Eurozone leaders due to meet in Brussels on Thursday to discuss a second bailout package for Greece and the financial stability of the Eurozone.
The USD struggled on Friday night as US politicians have not reached an agreement to lift the government's debt ceiling. The ratings agencies have warned an agreement must be reached by August 2 in order to prevent a credit rating downgrade.
The US data outturns did little to encourage hopes the recent soft-patch is temporary. CPI for June was lower-than-expected (-0.2% vs -0.1% expected), the Empire Manufacturing index for July dropped to -3.76 (vs 5 expected) and the University of Michigan consumer confidence declined for July to 63.8 (vs 72.2 expected).
The CAD was the best performing currency on Friday against the USD. USD/CAD shed ¾ cent to 0.9530 over the evening and is now at its lowest level since May this year. The CAD was spurred higher by a decent rise in oil prices. In addition, the market is looking to the Bank of Canada interest rate decision on Wednesday morning. Analysts unanimously expect no change, but over the next 12 months the market is pricing 45bps of rate hikes from the BoC.
Looking to the week ahead, expect the European debt crisis and US debt ceiling agreement to dominate currency direction. Data wise, markets will be looking to the Philadelphia Fed index for signs the US soft-patch is coming to an end. In Europe, the focus will be on the ZEW and IFO surveys for Germany and PMI manufacturing and services for Germany and France. The highlight in the UK will be on the BoE minutes from the July MPC meeting.
Fixed Interest Markets
NZ interest rate markets were relatively subdued on Friday. Short-end yields ended the week a couple of bps higher, but long-end yields ended meaningfully lower. On Friday night, US 10-year yields declined after weak US data releases.
NZ 2-year swap yields ended the week slightly higher at 3.42% after the positive surprise to Q1GDP. 10-year yields ended the week at 5.16%, 9pbs lower on the week, dragged down by declining off-shore yields.
Similar dynamics were seen in bond markets. The rally in 10-year bond yields over the week was pronounced, with the yield on 21s falling 17bps to 4.98%. This has resulted in the 10-year bond swap spread rising to 18bps.
The flattening in NZ curves continues to be driven by the combination of positive domestic data supporting the short-end, while negative global risk sentiment weighs on the long-end.
US 10-year yields declined to 2.90% on Friday, following weak economic data releases covering both the manufacturing sector and consumer confidence. Rating agency S&P also indicated there was a 50% chance that the US will lose its top AAA credit rating. It suggested it maintains concerns, even if Congress reaches an agreement on raising the debt ceiling.
German 10-year yields also fell from 2.74% to 2.69% as European concerns continued to drive demand for “safe haven” assets. Greek 2-year bonds rose to new highs at 33% and Irish, Portuguese and Italian 2-year bond yields also pushing up to new highs. This occurred despite the Italian Prime Minister Berlusconi passing €40bn in deficit cuts in order to balance the budget by 2014.
Australian yields fell further than their NZ counterparts last week. Australian 10-year swap yields fell 26bps to 5.59%, and 3-year swap yields fell 37bps to 4.89%. This resulted in the NZ-AU 3-year swap spread becoming less negative, moving from -1.43% to -1.10%. OIS markets are now pricing around 50bps of rate cuts from the RBA over the coming 12 months. We do not expect the RBA to cut rates.
Markets now price over 60bps of rate hikes from the RBNZ in the coming year following last week’s upside surprise on Q1GDP. We continue to forecast 125bps over the same period. On this basis we see “fair value” on 2 and 3-year swap yields at around 3.95% and 4.30% respectively.
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See our interactive swap rates charts here and bond rate charts here.
Mike Burrowes and Kymberly Martin are part of the BNZ research team.
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