NZD/USD was the best performing currency on Friday, supported by expectations the RBNZ will deliver a more hawkish statement on Thursday. Positive global equity markets also help to support the currency.
Despite a modestly stronger USD, NZD/USD spent Friday night oscillating around the 0.8650 level. The NZD made some ground on the crosses with the trade-weighted index now above 74.00. NZD/EUR rose to 0.6020 from 0.5980. NZD/GBP spent most of the evening above 0.5300. NZD/AUD recovered from below 0.7930 to above 0.7960 currently.
While NZD/USD remains well supported, our “fair value” model continues to suggest the move higher is ahead of ‘fundamentals’. This suggests the risks are skewed to a small pullback over the coming months. Our NZD/USD “fair value” range has moved up 2 cents over the past week to 0.7450 to 0.7650. The move higher in the “fair value” range was driven by the NZ-US 3-year interest rate differential widening to 3.08% from 2.83%.
Our NZD/AUD “fair value” range continues to track higher with the move in spot. The “fair value” range has moved up a cent to 0.7680 to 0.7880. The move higher in the “fair value” range was driven by the NZ-AU 3-year interest rate differential becoming less negative, moving to -91bps, from -106bps.
There is no shortage of event risk for the NZD this week. On Tuesday we have the Trade Balance, the NBNZ business survey on Wednesday and the RBNZ interest rate decision on Thursday. In Australia, the focus will be on Tuesday’s CPI for Q2 and a speech by RBA’s Edey today.
The USD eked out a small gain against nearly all the major currencies on Friday. The EUR took centre stage as investors worried about how the expanded EFSF will be implemented. Only the AUD and NZD posted gains against the USD.
The focus on Friday night shifted to how the expanded EFSF will be implemented. In addition, ratings agency Fitch warned Greece may be placed in ‘restricted default’ under the proposed EFSF plan. Given these concerns EUR/USD gave back some of the gains from Thursday night, falling from around 1.4400 to 1.4350 currently.
The ongoing US debt ceiling debate partially offset the weakness out of Europe. For now we expect the Democrats and Republicans to cobble together some sort of compromise before the August 2 deadline. Beyond this, expect further debate between the two parties on a longer-term plan to reduce the US deficit. A credible deficit reduction plan could provide support to the struggling USD.
The ongoing concerns around the US debt ceiling saw USD/JPY briefly slip to a 4 months low of 78.20. This is the lowest level since the joint G7 intervention in March, following the Japanese earthquake. The JPY gains were fully reversed after Japanese Finance Minister Noda noted he was watching currency moves carefully. This suggests currency intervention could be considered if the JPY continues to appreciate.
Canadian CPI for June was weaker-than-expected at 3.1% (3.6% expected). The CAD was the worst performing currency for the evening, with USD/CAD rallying from 0.9940 to 0.9480 currently. Despite the weak data, the OIS market still expects around 60bps of rate hikes from the Bank of Canada over the next 12 months.
The AUD and NZD remained better supported on Friday night as they tracked the small rise in global equites. The S&P500 and Euro Stoxx 50 index ended up 0.10% and 0.30% respectively. AUD/USD reached a high around 1.0870, but has fallen back to 1.0840 currently. The break above the 1.0800 level last week has seen focus shift to the post-float high at 1.1000
Looking to the week ahead, expect more focus on the US debt ceiling debate given the looming August 2 deadline. The market will get some more hints on future Fed policy, with the Fed’s Beige book released on Wednesday and several Fed members speaking over the course of the week.
We also have US GDP for Q2 and Michigan consumer confidence survey. The focus in Europe will be on German consumer confidence and Eurozone CPI for July. The data highlight in the UK will be Q2 GDP.
Fixed Interest Markets
NZ yields continued to rise on Friday as the market revised up RBNZ rate hike expectations. The Eurozone came to a deal on Greece while US debt ceiling negotiations continued without resolve over the weekend.
NZ swap and bond yields continued their march higher on Friday. 2-year yields surged as high as 3.72% early in the morning, before profit-taking halted the rise. Yields closed at 3.69%. 2-year yields have now risen 37bps in less than a fortnight.
Markets are now pricing close to 90bps of rate hikes from the RBNZ in the next 12 months. We expect the OCR to be 150bps higher in a year’s time, and see “fair value” for 2-year and 3-year swap yields at 4.20% and 4.50% respectively.
NZ bond yields also moved higher by 3-4bps along the curve on Friday. As the rises in yield have generally been greater for swaps than bonds, 10-year swap spreads (EFP) have widened to almost 23bps.
On Friday, Australian swap yields also rose, with 3-year yields moving from 4.87% to 4.95%. OIS markets are still looking for close to 40bps of rate cuts from the RBNZ over the coming 12 months, expectations we believe will be reversed. The NZ-AU 3-year swap spread widened to -91bps on Friday from -85bps the previous day.
Off-shore, European officials agreed a new bail-out plan for Greece which included private bondholder participation for the first time. It also provided commitment from European leaders to support Greece’s debt obligations until it can eventually return to capital markets. Private bond holders will have the choice of debt exchange or rollover plans.
The plan will mostly likely result in credit rating agencies declaring Greece to be in “selective default” for the few days it takes for bonds to be exchanged. Officials have gone to pains to define the solution as being for Greece only, specifically excluding it as an option for other Eurozone countries in difficulty.
Peripheral European bond yields and CDS spreads have fallen meaningfully from highs. Greek 2-year yields (non-funding) fell from 39.0% to 27.6% last week. Spanish and Italian 10-year yields fell to 5.7% and 5.4% respectively.
On Friday, US 10-year yields fell from 3.00% to 2.96%. Protracted weekend negotiations are yet to see a final resolution in the US debt ceiling debate. The deadline is now just over a week away.
Expect further upward pressure on NZ yields this week, though with a bit more volatility as we head into Thursday’s meeting.