US dollar unlikely to have its usual strong 'safe haven' appeal; Kiwi may not suffer as harshly as normal in times of risk aversion

By Kymberly Martin

Kiwi dollar

The NZD was a little firmer on Friday, after a week of notable losses. It traded up from 0.8350 to 0.8450. This leaves it around 4.10% below the post-float highs, above 0.8800, reached last Monday. On Friday, our risk appetite (scale 0-100%) fell to 35.9%, below its March low, to levels last seen in June 2010. Market sentiment improved a little during the night after the release of US payroll data that was better than expectation.

The NZD was on a solid footing relative to the AUD on Friday, rising from 0.8000 to 0.8080, its highest level since July last year. On a relative basis, the AUD is being pressured by the market increasing its expectations for rate cuts. This has seen the NZ-AU 3-year swap spreads become less negative, moving to -0.70% the highest level since August last year. The NZD traded choppily relative to both the EUR and GBP on Friday. The GBP/USD closed around 0.5140 to consolidate a 4.3% fall on the week.

The NZD/EUR closed around 0.5910 on Friday night. The week ahead is light on NZ data. Today’s house price data and tomorrow’s electronic card data are unlikely to be significant market movers. Thursday’s Business PMI and consumer confidence will be important, though global developments will be key this week.

Given the US rating downgrade over the weekend (see below) expect volatility in currency markets. The NZD should not suffer as harshly as might traditionally be the case in times of risk aversion, given that in the current environment the USD should not have such strong “safe haven” appeal.

Majors

Last week the USD was broadly stronger as global risk appetite collapsed and the USD acted in its traditional “safe haven” capacity.

The only currency to outperform the USD over the week was the CHF, despite the Swiss National Bank’s attempts to weaken the currency. The weakest performing currencies last week were the NZD/USD and AUD/USD, down 4.10% and 5.00% respectively.

On Friday, risk aversion remained high with the VIX index (proxy for risk aversion) spiking as high as 39, before returning to 32, still above its March spike to 29. The Euro Stoxx 50 declined a further 1.50%. The S&P500 however, staged an intraday reversal to close almost flat. The much anticipated July US payroll data came in better-than-expected at 154K (113K expected), helping to improve sentiment slightly. The USD index eased from 75.2 to 74.6. The EUR/USD had a solid day of trading on Friday, reversing the weakness seen earlier in the week. It climbed from 1.4100 to 1.4290, despite a disappointing German industrial production number for June at -1.1%m/m (0.1% expected).

The USD/JPY traded around 78.50 on Friday, consolidating its position after the Bank of Japan’s intervention, earlier in the week. Intervention successfully brought the USD/JPY off its lows below 77.00. Its current levels however, are still in line with where the G7-coordinated intervention in the JPY back in March. The AUD and NZD both traded choppily on Friday, consolidating their positions after their losses earlier in the week. The AUD/USD ended the week trading around 1.0440, at the bottom of its range of the past 4 months. With the escalation of off-shore concerns OIS markets have moved to price in almost 140bps of rate cuts from the RBA in the coming year.

We believe that the RBA will maintain a tightening bias given the inflationary pressures inherent in the Australian economy. Reversal of expectations will ultimately support the AUD/USD, though this will require some stabilisation in off-shore events. Over the weekend, the key development has been rating agency S&P’s downgrade of the US sovereign rating for the first time since 1941. (see interest rate section below).

Expect volatility in currency markets in the week ahead. While risk appetite will remain elevated, we would not expect the USD to act in its traditional “safe haven” capacity in the coming days, as the key “risk” event is focused on the US.

Expect the JPY and CHF to test the resolve of their respective central banks, as they face “safe haven” demand.

Fixed Interest Markets

Following moves seen in off-shore markets, NZ interest rate markets rallied sharply on Friday. Over the weekend rating agency S&P downgraded the US to AA+, maintaining a negative outlook. In swap markets, 2-year yields declined 21bps to 3.35%.

This eliminates all of their recent rises, to trade back in the middle of the range they had traded in from April this year until mid July. Markets have revised down expectation for RBNZ rate hikes to less than 60bps in the coming year. 10-year swap yields declined 14bps to 4.94%, resulting in some steepening in the 2s-10s curve to 158bps. Bond yields also declined. The yield on 13s declined 21bps to 3.04% and the yield on 21s fell 17bps to 4.56%.

The yields on 21s are now at the lowest level since March 2009. As bond yields fell more heavily than swaps at the long-end, 10-year EFP has risen to 37bps, the highest level since November 2009. On Friday, 10-year yields had rebounded off recent lows rising from 2.35% to 2.55%, after US payroll data was slightly firmer than expected. German bund yields also rose from 2.25% to 2.35%.

The most significant development in interest rate markets occurred after the close of trading in the US on Friday. S&P downgraded the US’s sovereign rating from AAA to AA+, maintaining a negative outlook. The US had previously held its top rating since 1941. The S&P highlighted two factors for the downgrade.

First, recent political wranglings in Washington has diminished the US’s credit standing. Second, the agency believes the recent US debt deal did not go far enough to ensure a sustainable debt outlook. In Europe, over the weekend it was reported that the ECB has agreed to start buying Italian bonds from this week, in exchange for accelerated deficit cuts. Italian and Spanish 10-year bond yields continued to hover above 6% on Friday.

It is likely to be a volatile week in interest rate markets as news of the US downgrade is absorbed, and markets continue to eye developments in Europe. It is a slim week for NZ data with Thursday’s Business PMI and Consumer confidence being key.

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

Kymberly Martin is part of the BNZ research team. 

All its research is available here.