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Euro debt worries soothed but US debt ceiling still looms. NZ$ interest rates rise

Currencies
Euro debt worries soothed but US debt ceiling still looms. NZ$ interest rates rise

 
By Mike Burrowes and Kymberly Martin

The NZD/USD has made a fresh post-float high overnight around 0.8640. Overnight sentiment in FX markets was buoyed by an announcement from the EU summit and ongoing concerns around the US debt ceiling (see below).

The risk sensitive AUD, CAD and NZD have underperformed relative to the European currencies overnight. This saw the NZD give back some of its recent gains on the crosses. NZD/EUR is trading just below 0.6000, from around 0.6020. NZD/GBP dribbled below 0.5300 overnight.

The NZD/AUD cross briefly jumped above 0.8000 yesterday, but has fallen back to 0.7960 overnight. The cross remains well supported by the market moving forward RBNZ rate hike expectations. Indeed yesterday we brought forward our RBNZ view, now calling for a 25bp hike in September and October and 150bps of hikes over the next 12 months. We expect relative interest rate and growth differentials will continue to favour a move higher in NZD/AUD over the next 12 months.  

So why have we adjusted our RBNZ call? Well, economic indicators are more robust than many expected and certainly far more robust than the Reserve Bank had feared. Financial markets too have come to accept this with a rate hike 100% priced for October and almost 50% priced for September. We believe the Reserve Bank has little option but to also accede to these developments if for no other reason than to maintain its own credibility.

With no data out locally, expect the NZD to takes its cues from developments offshore. In this regard, we have the HSBC Chinese manufacturing PMI. We expect initial support on NZD/USD at 0.8600 and resistance around 0.8650.

Majors

The USD was pressured lower overnight by an improvement in risk appetite and ongoing debate about raising the US debt ceiling. The USD index fell 1% to 74.15 but is still around 5% off its historic low reached in 2008.

The big move in FX occurred early this morning, after the Eurozone leaders announced new powers for the EFSF to give loans to troubled countries earlier, recapitalise banks and to intervene in the secondary bond market. Importantly, the ECB agreed to allow selective default on Greek bonds. As a result, the private sectors will share some of the burden via a bond swap and debt buyback.

The Eurozone announcement spurred a broad based rally across most asset classes.  The Euro Stoxx 50 equity index closed up 2.3%, with the financials sector up a whopping 4.6%. The VIX (proxy for risk aversion) fell from to 19.0 to 17.7.

Trading on EUR/USD was very volatile, initially shedding over a cent to 1.4140 during the evening. Weaker-than-expected Eurozone PMI composite for July (50.8 vs 52.6 expected) and concerns about the EU leaders meeting were the main drivers. However, following the EU announcement EUR/USD surged from 1.4150 to around 1.4380 currently.

The move higher in the EUR dragged other risk sensitive currencies higher. AUD/USD charged from 1.0700 to around 1.0840 currently. USD/CAD fell from 0.9490 to 0.9450 currently.

The GBP was better supported during the early evening after UK Retail Sales for June were better-than-expected at 0.7% (0.6% expected). GBP/USD has risen from 1.6170 to around 1.6300 currently. However, we expect GBP/USD to struggle above 1.6500 as fiscal austerity measures continue to weigh on UK growth.

Looking to the night ahead, expect more focus on the US debt ceiling debate given the EU summit has now passed. There is little in the way of data, with only the German IFO and Eurozone industrial new orders due to be released.
 
Fixed Interest Markets
NZ swap yields continue to rise steeply. Bond yields were more contained given strong demand at auction. Overnight, off-shore “safe haven” bonds sold-off as risk appetite improved.

Yesterday the DMO auction saw robust demand with a total of $1,468m bids for $200m offered. Bidding was heavily weighed toward 15s, with 19s seeing less than a 2x bid-to-cover ratio. Consequently, yields on 13s and 15s declined 1bps on the day. Longer bonds sold-off slightly with the yield on 21s rising 2bps to 5.07%.

Swap yields continued their rapid march higher, instigated from the short-end. Early in the day the yield on 2-year swaps rose as high as 3.65% before profit-takers took the yields back to 3.63% on the close. The yield on 10-year swaps rose 7bps to 5.29%. The meaningful sell-off in swap markets while bonds were more subdued saw 10-year swap bond spreads widen further to 22bps.

Despite the significant rise in swap yields over the past few days we believe we are still someway below “fair value”. We now expect the RBNZ to begin raising rates with a 25bps hike in September, gradually removing monetary stimulus. On this basis, we see current 2 and 3-year “fair value” at 4.20% and 4.50% respectively. Given this, we expect the sell-off to continue.

Overnight, risk appetite improved, as European officials haggled their way toward the latest proposal in the European debt crisis. “Safe haven” bonds sold-off with US 10-year yields rising from 2.94% to 3.00%. German 10-year yields rose from 2.80% to 2.88%.

The yield on peripheral European bonds declined, narrowing their spread to German bunds. The yield on 10-year Spanish and Italian bonds fell to 5.73% and 5.34% respectively. Peripheral sovereign CDS spreads have also fallen sharply from their peak, as markets price a reduced probability of default.

Expect upward pressure on NZ yields along the curve today, following off-shore developments. There are no NZ data releases.

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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. 

All its research is available here.

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10 Comments

 How big is this thing going to be for the rest of the world ?

Are NZgovernment officials listening ? Then please act.

 http://www.youtube.com/watch?v=goI8rAAJKtE

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"Soothed".....love it....what a joke...tonight across Europe any sucker holding Greek IOUs will be "soothing" their pants.

 

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like soothing a severed leg with a panadol.

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86 cents Americano...woopee...parity soon...cheaper fuel...cheaper imports from Obamaland...lower cost of production...farmers holding back from the promised splurge on lower Kiwi$ returns..remember that BS a few months back how farmers would blow it and save the economy....fat chance of that....oops that means the 170ooo jobs as promised by National are pie in the sky...as expected.

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And, best of all...a better rate for those of us departing to take our funds out at!

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True.... but take them where?

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Makes the new international currency of GOLD cheaper to buy.

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Wolly said "86 cents Americano...woopee...parity soon...cheaper fuel...cheaper imports from Obamaland...lower cost of production..."

Dream on! When the price of oil goes up, the price of petrol goes up...when the price of oil comes down, the price of petrol goes up. It doesn't matter what the exchange rate does because these people can always find a way to keep gouging.

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But look what its doing to US milk exports

http://www.xcheque.com/xcheque-blog/all-blogs/5153-us-milk-production-l…

   

It is easy to see that since 2002 the US has developed an active interest in export markets. This has fueled additional milk production with 40% of milk production growth being directed to export markets. The balance has supported an ongoing increase in domestic demand (linked to population growth).  

These charts show very clearly that US dairy farmers and processors can and will respond to export opportunities if the price is right. Furthermore, they respond very quickly to price rises and falls - it just takes a small turn of the feed dial to add or subtract a billion litres to US and global milk production. Australian and New Zealand processors have always seen Europe as their primary competition for international markets. There is no doubt that they now have a nervous eye on the growing interest and capability of the US.
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Kiwi breaches 0.87 and is given home detention

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