Sentiment now very negative; massive and prolonged 'risk off' situation

By Sam Coxhead*:

Last week’s initial euphoria that followed the agreement to raise the US debt ceiling was short lived, and what followed will be remembered as one of the bloodiest weeks in the markets for some time.

With the Euro zone debt crisis again looming bigger and potentially harder to solve than ever, in the form of Italy and Spain and with US economic data on the whole continued its weak run, the already fragile global economic outlook took a dive.

Sentiment drives markets, and sentiment last week changed to very negative, leading to a massive and prolonged 'risk off' session.

What resulted was one of the worst weeks for equity bourses since 2008, as investors fled.

The high flying 'risk asset' currencies of New Zealand  and Australia were unceremoniously dumped.

While there was always a reasonable chance of a US downgrade from ratings agency Standard and Poor’s, it still came as a landmark shock to the markets.

Major Announcements last week:

· Democrats and Republicans agree on a deal to raise the US debt ceiling
· China's official Purchasing Managers Index falls for fourth consecutive month
· UK Manufacturing PMI lower than expected – causes GBP weakness
· US Manufacturing ISM described as “a shocker”, indicates economy is weak
· Ratings agency Fitch leaves US credit rating at AAA
· Ratings agency Moody’s leaves US credit rating at AAA, on negative watch
· RBA leaves cash rate unchanged at 4.75
· Australian Retail Sales monthly data weaker than expected
· NZ Unemployment rate remains unchanged
· European Central Bank leaves interest rates unchanged as expected
· UK Construction PMI better than expected
· Bank of Japan intervenes in the currency markets to drive down the value of YEN
· Italian and Spanish debt under pressure, Spanish 10yr yield highest since 1997
· Canadian Unemployment rate falls to 7.2, its lowest level since 2008
· Ratings agency Standard and Poor’s downgrades US credit rating to AA+ 

NZD/USD 
Last week saw the NZDUSD at one point down nearly six cents, as investors dumped “risk asset” currencies, in response to the unfolding events in the US and Europe. Whilst it did rally in the Friday night session, it has again suffered today, to be again at last week’s lows at the time of writing.  Markets will this week continue to see extremely high levels of risk aversion. Therefore a further sharp fall in the NZDUSD cannot be ruled out. However at some point it has to be remembered that the NZ economy is significantly healthier than most others globally. As long as China, and therefore our biggest trading partner Australia remain at relatively upbeat levels, the higher level of NZD that we have become accustomed to of late may well continue. This week there is no tier one data out in NZ. Therefore direction will be solidly driven by offshore events, as the NZDUSD mirrors to a large extent the appetite for risk.

NZD/AUD (AUD/NZD)
Last week’s deteriorating outlook for the global economy, and therefore commodity and “risk asset” currencies such as the NZD and AUD saw both currencies hammered lower against the USD. As a result the NZDAUD traded a relatively choppy range, as both currencies slid and played catch up, at different points. The net result however was a stronger NZD relative to the AUD. Whilst the chances of a rate hike from the RBA last week was by no means high, their no change response and comment disappointing the markets, with the NZDAUD spiking almost a full cent higher on its release. Weaker Australian retail sales and an unchanged NZ rate of unemployment then provided further reason for NZD strength, relative to the AUD. With Australian data on the whole continuing to be softer than that of NZ, further tests of the NZDAUD topside may be likely in the coming weeks.  There is no tier one data out in NZ this week. Important business confidence and consumer sentiment surveys out in Australia this week should mean little, as these readings were take pre last week’s events. Unemployment data on Thursday however will be watched closely.

NZD/GBP (GBP/NZD)
The NZDUSD shed almost six cents last week, as global markets tumbled. Whilst the GBPUSD traded a volatile range, it ended the week almost unchanged against the USD. Therefore the NZDGBP went backwards at a rate of knots, to dip at one point back below .5100 in the interbank market, for the first time since early July . This trend has continued today, with the current level now a half cent lower again. There is no tier one data out in NZ this week. In the UK we have a key manufacturing index released on Tuesday evening, followed by the all important BOE quarterly inflation report due on Wednesday night (NZT). The inflation report is a key release, as it contains the BOE’s projections for inflation and growth for the next two years. However given the level of market turmoil will no doubt continue this week, direction in this cross will again mainly be driven by the markets appetite for risk, and therefore from the performance of the NZDUSD. Current levels now provide significantly better levels to buy NZD with GBP, than has been the case for quite some time.

 
NZD/CAD
Along with most other NZD crosses last week (NZDAUD being the exception), the NZDCAD dropped considerably, as the NZD was dumped relative to the USD. Both countries had key unemployment data out last week. Whilst the NZ rate remained unchanged in line with market expectation, the Canadian rate came in far better than anticipated, and at 7.2%, is the lowest level since 2008. This provided an additional reasons for the CAD to appreciate, relative to the NZD. Continued high levels of uncertainly this week, should see risk currencies such as the NZD again shunned. Therefore further tests of lower levels are likely. With no NZ tier one data out this week, Canadian trade balance data due for release on Friday evening, is the only major date release of the two countries. Whilst it is quite a dated data set, with 65% of Canada’s exports being purchased by the US, it will provide a good insight again into the strength of the US economy.

NZD/RAND
While the NZDRAND did dip last week, given it was less than a one percent slide on the prior week’s lows, it was hardly of consequence, considering moves in other currency pairs. Whilst the NZDUSD gave up nearly six cents on the week as fear gripped the markets and “risk assets” we sold hard, South Africa continues to face issues that threaten to weaken its own economy. SARB’s Daniel Mminele indicated Europe’s spiralling debt crisis may undermine SA’s economic outlook further, at a time when growth indicators are already weakening. Europe buys about a third of South African manufactured exports, so any further curbing of spending from that region will no doubt have an impact. Also, on Friday a report surfaced that again painted a gloomy picture of SA as an investment destination. Sighting increased strike action, and the possible nationalisation of mines, the report concluded direct foreign investment in SA this year could again be well lower, having already suffered a 70% drop last year. Therefore for those looking to buy NZD sell RAND, whilst the NZDUSD may remain under pressure this week, it may not contribute to wholesale lower levels of the NZDRAND.

NZD/EURO (EURO/NZD)
As was the case with the New Zealand dollars value relative to the USD and GBP last week, the NZDEUR rate also eased significantly. With the Euro zone debt issues again building to an explosive point, and therefore one of the main causes of last week’s turmoil, the NZDEUR move lower is directly attributed to the markets dumping of “risk assets”. With the NZD having been one of the stand out currencies this year, being a key currency “risk asset”, NZDEUR was hit hard. The ECB is today rumored to be considering buying massive amounts of Italian and Spanish debt. If this proves to be correct, this will go some ways to placating market fears of a boil over at this point. A further easing of this cross may be the  likely result, if these rumors prove to be true. Both NZ and Euro zone are light on data this week, therefore moves in this cross will be solidly dictated by ECB announcements, and the market risk appetite.

 
NZD/YEN (NZD/YEN)
Unlike most other NZD crosses last week (with the exception of the NZDAUD), this cross traded within a volatile range, as opposed to simply continually breaking lower. Obviously events in the US and Europe were the key drivers initially. However the BOJ intervention into currency markets on Thursday, in an effort to weaken its currency, initially saw the NZD claw back some lost ground. But as is often the case when central banks intervene, the BOJ’s impact was short lived, as the YEN’s supposed safe haven status was again supported by the market. Both countries are light on data this week. With high levels of risk aversion sure to be seen, the chances of a weaker NZD is again present. However Japanese officials comments suggest BOJ intervention remains likely. Whether or not they have any more success than last week, remains to be seen.

AUD/USD
Last week saw the AUDUSD down almost seven cents at one point, as global growth concerns lead to a massive “risk off” session in the markets. Whilst the market arguably had not expected a rate hike from the RBA, their no change announcement did add to AUDUSD weakness. This week markets will continue to experience extremely high levels of uncertainly, with risk aversion being the result. With this in mind it’s hard to imagine any AUDUSD appreciation of significance. If the level of fear that gripped markets last week continues, then AUDUSD could easily suffer further losses. Worth noting also is last week a key manufacturing growth indicator in China was released, with a decline for the fourth consecutive month being shown. This points to Beijing’s tightening measure having good effect. With the Australian economy being so reliant on Chinese consumption, a growing Chinese economy has always been a good insurance policy, against the economic slowdown in other regions. Obviously with the global economic outlook now looking very pessimistic, Australian needs China to remain buoyant. Therefore Chinese economic indicators will now be to watched closer than ever.

AUD/GBP (GBP/AUD)                            
The AUDGBP suffered the same fate as the NZDGBP last week, as both currencies were dumped relative the USD, whilst the GBP remained largely unchanged. This week will continue to see extremely high levels of risk aversion, as the debt situation of both Italy and Spain, threaten to boil over, and a continued revision of the state of the global economic outlook is priced into the markets.  In terms of local data out, Australian employment data due for release on Thursday will be the key event AUD wise. Business confidence and consumer sentiment surveys due for release will be of little value, given the data is older than last week. In the UK this week’s most important event is the BOE’s quarterly inflation report due for release on Wednesday night. The inflation report is a key release, as it contains the BOE projections for inflation and growth for the next two years. With this cross rate having been so elevated for so long, current levels now present those with GBP the opportunity to finally buy AUD, at more favorable levels.

 
AUD/EURO (EURO/AUD)
With the AUDUSD getting well and truly trashed last week in a massive “risk off” session in the markets, the AUDEUR gave up nearly four cents in what was one way traffic lower, once the initial positive feel from the US debt ceiling agreement subsided. Whilst the Euro zone debt woes are and remain one of the key concerns globally, and again threatened to boil over last week, the EURO’s fortunes held up better relative to the USD, as both battled again for the prize of whose issues look the ugliest. The ECB is now rumored to be considering buying massive amounts of Italian and Spanish debt, in an effort to stabalise markets. Australian unemployment data due out later in the week will be watched closely, but is likely to pale into insignificance in terms of direction for the AUD, with the general market appetite for risk, and any ECB announcements being the key drivers.

GBP/USD
Last week saw the GBP one of the only currencies that stood up well to the USD, as the market deserted growth assets, and fled to safe haven assets. Whilst US developments were of course one of the key contributors to last week’s massive risk off session, and the downward revision of global growth prospects, when a risk off session hits the markets, the USD still holds safe haven status, at least for now. Both the US and the UK obviously have their problems, but the UK clearly took a different approach some time ago, with the implementation of austerity measures, to bring their accounts under control. The US arguably took the opposite approach, by looking to borrow and spend to reignite growth. Therefore, with the US short and long term outlook now looking decidedly pessimistic, perhaps the GBPUSD will now look to move upwards, back towards longer term historical average levels.

475
GBP/EURO (EURO/GBP)
Last week’s trade in GBPEUR was extremely volatile in nature, as Euro zone debt issues and US drama’s battered this cross rate within a relatively tight trading range. The winner on the week was the GBP. This week expect more of the same, with a continued bias to a stronger GBP, as the Euro zone debt crisis continues to boil. Key events to watch with be the BOE Inflation report due late week, and of course any ECB announcements. If rumors that the ECB is looking to buy massive quantities of Italian and Spanish are true, then a EURO relief rally will no doubt ensue at some point.

GBP/RAND
Last week the GBP held up well relative to the USD, which has been bought due to its continued “safe haven”. With continuing weak data and a gloomy economic outlook for SA, GBP strength translated into an appreciation of close to five percent over the RAND. With the UK already in the process of addressing their economic and fiscal issues, and the prospects of SA looking likely to get worse rather than better, possibly the GBPRAND will continue to appreciate from here.  Certainly comments out in the last few days do not paint a rosy picture for the SA economy. SARB’s Daniel Mminele indicated Europe’s spiralling debt crisis may undermine SA’s economic outlook further, at a time when growth indicators are already weakening. With Europe buying about a third of South African manufactured exports, any further curbing of spending would obviously have an impact. A report underlying the view that direct investment in SA was becoming increasingly risky also surfaced, which will only add to negative RAND sentiment.

Market commentary:

Last week’s initial euphoria that followed the agreement to raise the US debt ceiling was short lived, and what followed will be remembered as one of the bloodiest weeks in the markets for some time. With the Euro zone debt crisis again looming bigger and potentially harder to solve than ever, in the form of Italy and Spain and with US economic data on the whole continued its weak run, the already fragile global economic outlook took a dive. Sentiment drives markets, and sentiment last week changed to very negative, leading to a massive and prolonged “risk off” session. What resulted was one of the worst weeks for equity bourses since 2008, as investors fled. The high flying “risk asset” currencies of New Zealand  and Australia were unceremoniously dumped. While there was always a reasonable chance of a US downgrade from ratings agency Standard and Poor’s, it still came as a landmark shock to the markets.

However it was not all bad. US credit data (a measure of consumer spending) posted a reasonable increase in June, the first consecutive monthly increase in two years, and a healthier than expected US jobs report was released on Friday. The European Central Bank (ECB) is also rumored to be considering buying massive amounts of both Italian and Spanish bonds, in an attempt to stabalise the debt crisis in that region. Also, whilst the US downgrade has both historical and political significance, and will obviously increase US borrowing costs, the fact is the likes of United Kingdom and Canada are also AA+. So whilst significant, the ramifications are perhaps more long term in nature, with the short term market impact possibly less, than the psychological blow the US has suffered.

With the Australian and New Zealand economies being viewed as robust when compared to many others globally, both the AUD and NZD have been riding high in 2011. Both in recent weeks have been at, or close to, historical highs against the USD, GBP, and EUR. However in general when the global view turns sour, both get hit hard. Last week that was again the case, with both dropping approximately seven percent in value against the USD, in what was a steady week of continual decline, rather than the sharp fall that equity markets suffered in the last two days. Whilst it seems contrary to logic, although the bleak US economic outlook and fiscal position is one of the root causes of last week’s events, the US dollar is still seen as a safe haven, and has therefore has strengthened considerably.

With both the AUDUSD and NZDUSD falling largely in tandem, it was left to local data releases to determine NZDAUD direction. The winner again on the week was the NZD. A combination of no change to interest rates from the Reserve Bank of Australia (RBA), weaker than expected Australian retail sales data, and no change to the New Zealand rate of unemployment, saw the NZDAUD finish the week at just above .8070 (AUDNZD below 1.2390) in the interbank market, its strongest point for some time.

As can be expected, both the AUD and NZD faired the same against the GBP and EUR. Whilst both started the week on an initial positive note, by Wednesday the sell off was in full cry. Both are now at levels not seen in many months. Having been at such elevated levels of late, current levels therefore provide good buying of both NZD and AUD with USD, GBP and EUR.  The coming week will obviously be one where risk aversion will continue to be extremely high. Whether or not markets stabalise, will be the big question. In response to the global financial crisis of 2008, a fortune has been pumped into the global economy by governments, by various means, in an attempt to jump start growth. To date arguably the return on that investment has been very poor. Last week’s developments, put the US on notice that its level of debt is unsustainable. Therefore, future stimulus measures, if forthcoming, will no doubt be questioned by many, as to their potential level of effectiveness, and long term fiscal consequences.

Data wise this week there are no tier one releases in New Zealand. Australia sees new home loans, NAB Business Confidence, WPAC Consumer sentiment and employment data released. In the UK monthly manufacturing production data followed by the all important BOE quarterly Inflation Report is due for release. Euro zone is light on the data front this week, but the market will no doubt have plenty to digest, as the response from the ECB to the debt crisis is clarified. In the US Wednesday nights Federal Reserve interest rate decision and their accompanying statement will be key. The statement is their primary tool to communicate with investors about monetary policy. Given the events of last week, it will hold a far greater than normal level of importance.

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Sam Coxhead is a currency analyst with DirectFX You can contact him here >>