Greek and Italian default spreads at all time highs; Euro worries dominate trading

Greek and Italian default spreads at all time highs; Euro worries dominate trading

By Mike Burrrowes and Kymberly Martin


The NZD fell sharply on Friday night as the debt crisis in Europe took another turn for the worse. The spike in risk aversion saw NZD/USD fall from around 0.8340 to briefly below 0.8200. NZD/USD is currently trading at 0.8220.

The NZD trade-weighted index held up better, ending flat for the evening. NZD/EUR spent most of the evening hovering around the 0.6020 level. NZD/GBP fell from above 0.5220 to 0.5180.

Our NZD/USD “fair value” model continues to suggest the currency is overvalued based on short-term fundamentals. Over the past week, the implied “fair value” range has fallen almost ½ a cent to 0.7350 to 0.7550 currently . The “fair value” range was marked lower by a fall in the NZ-US 3-year interest rate differential from 3.01% to 2.90%.

NZD/AUD fell from 0.7860 to 0.7830 during Friday evening. The current level is broadly consistent with the implied range from our NZD/AUD “fair value” model of 0.7730 to 0.7930. However, should the RBNZ maintain its tightening bias on Thursday we favour the cross moving back into the 0.7900 to 0.8000 range.  

The highlight for the week will be on Thursday’s RBNZ September Monetary Policy Statement. The recent global ructions will likely put the kibosh on the 50bp hike strongly indicated at July’s meeting. Today’s Q2 wholesale trade data and Tuesday’s manufacturing survey will be critical for our Q2 GDP call of 0.4%.


The USD surged higher against all the major currencies on Friday as risk aversion pervaded trading. The USD index ended 1.2% higher at 77.20, its highest level since mid-March. Renewed concerns about the European debt crisis saw the European currencies lead the declines against the USD.

The spike in risk aversion was broad based. In equity markets, the S&P500 index and Euro Stoxx index ended down 2.7% and 4.2% respectively. The financial sector of the Euro Stoxx 50 index shed a whopping 6.7%. Our risk appetite index (scale 0 – 100%) fell to 29.3% from 31.1%. Commodity prices lost ground, with the CRB index (broad index of global commodity prices) falling 1.7%. Gold lost some of its “safe haven” allure as rumours circulated the Chicago Mercantile Exchange may raise its margin requirements from Monday. Gold prices fell 0.6% to USD1856 per ounce.

EUR/USD began to slide after surprise news that ECB member Stark was resigning over the Bank's purchase of peripheral Eurozone bonds. Following this, rumours circulated that Greece could default over the weekend. This was swiftly rejected by the Greek Finance minister. The negative news combined with the more dovish ECB policy statement on Thursday night has seen markets ramp-up expectations for rates cuts. Indeed, the OIS market now expects a 25bp cuts from the ECB before the end of the year and a total of 38bps of cuts over the next 12 months. EUR/USD collapsed throughout the evening from 1.3900 to around 1.3650, its lowest level since late-February this year.

The Eurozone woes saw EUR/GBP weaken from above 0.8700 to just below 0.8600, its lowest level since mid-March. However, the fragile UK economy and potential for more stimulus by the Bank of England will mean that trading on this cross is likely to remain volatile. GBP fell against the strengthening USD, from around 1.5960 to 1.5880.   

The Canadian employment data for August was much weaker-than-expected at -5.5k (vs. 21.5k expected). The surprise loss of jobs saw the unemployment rate rise to 7.3% (vs. 7.2% expected). USD/CAD surged from 0.9920 to around 0.9970 currently.

The data flow starts on Tuesday with the release of the UK trade balance and CPI. On Wednesday, we have Eurozone industrial production and US retail sales. Thursday is set to be the highlight, with UK retail sales; Eurozone industrial production; US CPI, current account, Empire manufacturing and industrial production. On top of this, ECB President Trichet is due to speak on Thursday. The week rounds out with Eurozone current account and US University of Michigan consumer confidence.    

Fixed Interest Markets

It was a quiet day in NZ swap and bond markets on Friday. On Friday night, US and German 10-year yields made new lows, as European debt concerns escalated.

NZ swap markets showed very little movement on Friday. 2-year yields closed up less than 1bp, at 3.29%, close to the bottom of its trading range. Longer-dated swap yields also closed up less than 1bps. With the 10-year swap yield at 4.69% the 2s-10s spread continues to trade around 140bps.

Bond yields also traded up by less than 1bp.10-year yields closed for the week at 4.51%, with the 10-year EFP now at around 18bps. Australian 10-year bond yields have fallen to 4.27%, 24bps below NZ equivalents. This AU-NZ spread is now at the lowest level since January this year. This spread will continue to imply downward pressure on NZ long yields, even though in absolute terms, NZ 10-year yields languish at close to early 2009 lows.

On Friday night, in an environment of heightened risk aversion “safe haven” US Treasuries and German Bunds were sought. US 10-year yields fell from 2.0%, to a new low of 1.89%, before creeping back to trade at 1.92%. German 10-year yields traded from 1.88% to new lows of 1.77%.

Within Europe, the focus has returned to Greece (see above). Greek government bond yields and CDS spreads (a measure of potential default) have spiked to new highs. Italian CDS spreads have also spiked to new highs, although Italian 10-year yields remain at 5.4%.

NZ yields will likely feel downward pressure again today, given heightened European uncertainty over the weekend. The key development this week for local interest rate markets will be Thursday’s RBNZ meeting. We expect at this meeting the RBNZ will remain on hold, but will restate the case for removal of their 50bps ‘insurance’ cut, as soon as there is greater clarity on global concerns. We believe that market expectations of just 40bps of rate hikes, from the RBNZ in the coming year, will ultimately be revised higher.

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

Mike Burowes and Kimberly Martin are part of the BNZ research team. 

All its research is available here.

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