The NZD spent the evening oscillating sideways despite the risk-off mood. The NZD remains well supported by encouraging local data and expectations rate hikes from the RBNZ will now come sooner than previously thought.
Yesterday’s Q2 CPI was higher than expected at 1.0% (vs 0.8% expected). The data confirms our view that there is little justification for the RBNZ to maintain the cash rate at 2.5%. For now, we’ll stick with our December rate call, but only just. It’s now a 50/50 pick between December and earlier. Furthermore, it’s also a 50/50 call on 50 or 25 for that first move.
NZ interest rate markets are now 30% priced for a 25bp hike from the RBNZ in September and 70% priced for October (see below). The reaction in currency market to the CPI data was swift with NZD/USD rallying from 0.8440 to around 0.8490. The move higher was short-lived however as a general risk-off theme during our day forced the currency below 0.8420.
Overnight the NZD has eked out modest gains on the crosses. NZD/AUD started the evening around 0.7950 and briefly reached a high around 0.7980. The cross continues to benefit from a narrowing in the relative interest rate differential. NZD/GBP hit a fresh post-float high overnight at 0.5270 as the GBP continues to struggle. For now, we expect NZ’s relative interest rate differentials to remain supportive for the NZD on the crosses.
With no data release locally, the focus will be on the RBA minutes from their July meeting. The market will be scrutinising the minutes for any hints on the next interest rate move. Any further retreat in tomorrow’s morning’s Fonterra’s auction prices might start to mean something.
Majors
The “safe haven” CHF, JPY and USD have outperformed overnight as a mild bout of risk aversion entered markets. It was again concerns around the European debt crisis that drove risk aversion.
The move in risk aversion was broad based. Equity markets declined across the board with the S&P500 index and Euro Stoxx 50 index dropping 1% and 2% respectively. The VIX index (proxy for risk aversion) surged from 19.5 to 21.5. Commodities have also succumbed to the risk-off mood with the CRB index (broad index of global commodities) dropping 0.8%. Oil lead the declines, plunging 1.7% on speculation the International Energy Agency could release another emergency stockpile to drive prices lower and support global growth.
The risk-off mood kicked into gear early this morning after the Spanish Prime Minister, Zapatero, stated he will not seek re-election. In addition, the German Chancellor Merkel noted private investors should contribute to bailing out Greece. Trading on EUR/USD was very volatile overnight, falling to a low around 1.4010 before recovering the losses late this morning to be around 1.4100.
GBP/USD was dragged lower by the move in the EUR, falling from 1.6120 to 1.6040 currently. In addition, investors are looking to the BoE minutes on Wednesday evening for any hints on the possibility of further asset purchases.
Current investor concerns around the European debt crisis and lack of agreement over the US debt ceiling is seeing investors move into perceived “safe haven” assets. In currency markets, this is reflected by the strength in the CHF, hitting a record against the EUR and USD yesterday. Gold is also benefiting from “safe haven” flows, hitting a record high overnight around US$1603.
Looking to the night ahead, expect the European debt crisis and US debt ceiling debate to dominate currency direction. Data-wise, in Germany the focus will be on the ZEW survey. The other major highlight will be the Bank of Canada interest rate decision.
Fixed Interest Markets
NZ short-rates sold off after the release of a stronger-than-expected Q2 CPI release. This saw OIS markets revise up expectations for RBNZ hikes. Overnight, European sovereign bond yields have made new highs.
Yesterday’s CPI release (1.0% vs. 0.8% expected) precipitated a sharp sell-off in short-end bonds. 2-year swap spreads closed 7bps higher at 3.49%, breaking above their trading range of the past 3 months. They are now at the highest yield since late February, immediately post the Christchurch earthquake. The 2s-10s curve flattened further to 168bps, as 10-year yields held around 5.17% given off-shore pressures.
OIS markets revised up expectations for RBNZ rate hikes to 80bps over the next 12 months. Our expectations remain unchanged at 125bps over the same period. We continue to expect the RBNZ to begin raising rates in December (a view held since February this year). However, we now see a meaningful risk of an earlier start to rate hikes.
Similar dynamics played out in NZ bond markets with the yield on 13s rising by 7bps to 3.30% and the yield on 21s more stable at 5.00%. The sharp rise in NZ short-end rates has further narrowed the NZ-AU 3-year swap rate spread. It is now around -0.94% up from -1.4% just a fortnight ago. Markets continue to price around 50bps of rate cuts from the RBA over the coming year.
Overnight, US 10-year yields inched higher from 2.89% to 2.91%. However, German 10-year yields declined from 2.69% to 2.65%, as European sovereign debt issues festered. Yields on peripheral European 2-year bonds made new highs, with Greek yields hitting 36%. Italian and Spanish 10-year yields rose to Euro-era highs of 5.90% and 6.30% respectively.
This takes them worryingly close to the 7% level that was deemed unsustainable by their smaller neighbours, prompting them to seek official assistance. July 21 looms as the next deadline when European officials meet to discuss European financial stability and the next Greek support program.
There is no NZ data in the day ahead, so markets will take their cue form off-shore developments. Expect curve flattening pressures to continue.
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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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