Volatile trading in currency markets as Euro default and bank strength concerns heighten

Volatile trading in currency markets as Euro default and bank strength concerns heighten

By Mike Burrrowes and Kymberly Martin

NZD

Trading in NZD/USD has remained very volatile overnight. Early in the evening, NZD/USD recovered from just above 0.8110 to 0.8240. These gains were short-lived as concerns quickly resurfaced about the European debt crisis, pressuring NZD/USD down to 0.8160. NZD/USD is currently trading around 0.8220.

The spike in risk aversion was broad based overnight. In equities, the French CAC dropped 4%, with the financials sector plunging 9.8%. The recovery in risk appetite in the past couple of hours has helped push the S&P500 index up 0.7%. Our risk appetite index (scale 0 – 100%) fell to 28.7% from 29.3% yesterday.

In this backdrop, AUD/USD has shed over 1 cent since the beginning of the week, to be trading around 1.0360 currently. This has seen NZD/AUD surge almost 1 cent to 0.7950. This move appears to be more related to short-term positioning. Indeed, the NZ-AU 3-year interest rate differential moved slightly in favour of the AUD, from   -79bps to -81bps currently.  

Trading in the NZD relative to the EUR and GBP was very choppy overnight. Early in the evening NZD/EUR fell to a low around 0.5970, but has subsequently recovered to above 0.6000. NZD/GBP recovered during the evening to above 0.5200, but has fallen back to 0.5170 early this morning.

Looking to the day ahead, we have the manufacturing survey for Q2. This will be critical for our Q2 GDP call of 0.4%. For the day ahead, we see support on NZD/USD at 0.8120 and resistance at 0.8220.

Majors
The USD rallied against most of major currencies overnight as risk aversion spiked higher. This has seen the EUR fall heavily at times and risk sensitive currencies struggle. Risk sentiment has partially recovered in the past hour.

The EUR remained very volatile overnight as the European debt saga remains in a state of flux. EUR/USD recovered during the evening from a low of 1.3500 to an overnight high of 1.3700. The move was supported by comments from the French Finance Minister Baroin, assuring investors that French banks could withstand a Greek default.

Following this, EUR/USD fell to 1.3560 early this morning as renewed concerns surfaced about the potential for a disorderly default in Greece. These concerns were reinforced by the Greek Finance minister, noting they only had 1month of cash left. In the last couple of hours EUR/USD has jumped from 1.3560 to 1.3680. The catalyst for the surge was an article in the Financial Times suggesting China is in talks to buy Italian bonds.     

The GBP has broadly tracked the extremely volatile moves in the EUR. GBP/USD surged to a high around 1.5880 during the evening, but fell to 1.5780 early this morning. GBP/USD is currently trading at 1.5860.

The European debt saga triggered demand at times for the “safe haven” JPY and CHF. USD/JPY plunged to 76.70 during the evening, but has recovered back to 77.30. The CHF strengthened against the EUR to 1.2050 from above 1.2100. Should the European debt crisis deteriorate further, expect the Swiss National Bank to vigorously defend the 1.2000 level. On Thursday evening the SNB is expected to leave rates unchanged and comment on its recent action to stem to rise in the CHF.

Looking to the night ahead, expect the focus to remain on the European debt crisis and the potential ramifications of a Greek default. The only data due for release is the UK trade balance and CPI.  

Fixed Interest Markets

Yields declined across the board yesterday. Swap yields fell more sharply than bond yields, further narrowing swap spreads (EFP).

NZ bond yields declined yesterday following falls in their off-shore counterparts over the weekend. The yield on 21s closed around 4.46% and the yield on 13s at 2.99%. However, moves across the Tasman were even more extreme with AU 10-year yields declining from 4.27% to 4.11%. This takes the AU-NZ 10-year spread to -35bps, its lowest level since September last year. Downward pressure on NZ long yields will likely therefore continue. However, until better interest is seen at DMO auctions, NZ bonds are likely to continue to under-perform off-shore counterparts.

Swap yields declined with some associated curve flattening. 10-year swap yields fell 8bps to 4.61%, while 2-year yields fell 5bps to 3.24%. The 2s-10s curve has therefore dropped to 137bps. Curve flattening pressure is likely to remain as we head into Thursday’s RBNZ meeting, i.e. the short-end is likely to remain relatively well anchored while off-shore events continue to weigh on long-end yields lower. EFP has continued to compress, with 10-year EFP now below 15bps, having peaked at close to 50bps in early August.

As risk aversion remained elevated overnight, in the backdrop of escalating concerns surrounding Greece, US 10-year yields showed volatile trading. They traded as low as 1.88% before returning to trade at 1.93%. German 10-year yields traded as low as 1.71%, now trading back at 1.74%.

In Europe, Italian and Spanish 10-year bonds have inched up to yield 5.57% and 5.33% respectively. CDS spreads in non-core Europe have also surged higher, as the market prices a higher risk of sovereign default. News reports cited recent meetings between Italian government officials and a Chinese investment company, which may lead to the latter’s purchase of Italian bonds. This could lead to some reprieve for this market.

The focus in the day ahead will continue to be on European developments, with downward pressure likely to remain on NZ yields, particularly at the long-end.

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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