Increased risk premium is being felt across the globe in funding markets

By Sam Coxhead*:

The European debt situation remains tense as news emerged over the weekend that Greece will most probably miss deficit targets in 2011.

The ECB, EU and IMF 'Troika' are back in Athens to make their assessments on whether or not to release the next 8 billion Euro in bailout funds. This news will not be greatly received by the markets.

The prospect of the increased deficit means the chances of default have increased and the pressure on the wider European banking sector again increases. To put this in context, the cost of insuring European debt is fast approaching levels seen at the peak of the global financial crisis in 2008.

This increased risk premium is being felt across the globe in funding markets.

It will have the wider implication of curbing growth through increased funding costs. An illustration of this is the double downgrade of New Zealand sovereign credit rating by agencies Fitch and S&P.

So overall risk aversion remains in place, commodity and equity prices are again being pushed lower, and demand for US dollars and US Treasury debt remains high.

Major Announcements last week:

· German IFO Business Sentiment 107.5 vs 107 expected
· US New Home sales 295k vs 265k expected
· US Durable Goods orders -.1% vs +.1% expected
· UK House Prices +.1% as expected
· US Weekly Jobless Claims dip to 391k vs 420k expected
· US Final GDP +1.3% vs +1.2% expected
· NZ Building Consents +12.5% vs +14.3% previous
· NZ NBNZ Business Confidence 30.3 vs 34.4 previous
· Canadian GDP +.3% vs +.3% expected
· US Chicago PMI (manufacturing) 60.4 vs 55.8
· Revised UOM Consumer Sentiment 59.4 vs 57.9
· Official Chinese Manufacturing PMI 51.2 vs 51.2 expected
· European initial Inflation estimate 3.0% vs 2.5% expected

NZD/USD 
The NZ dollar continues to see pressure from the US dollar as the uncertainty increases in global markets. The NZ credit rating downgrade did little to help the NZD’s prospects, but was not unexpected. This week sees the focus primarily on the US with just the NZIER quarterly survey of business opinion due for release on Tuesday. The main focus in the US will be on Friday with the release of the all important employment numbers. Before that that FED Chairman Bernanke speaks on Tuesday and any further insights to potential monetary policy actions will be acted upon. Expect initial support at .7550, sharp moves higher cannot be ruled out if the market gets caught with “sold NZD” positions, and we see a bounce in the commodity markets. This market will remain volatile.

NZD/AUD (AUD/NZD)
The NZD dollar came under a little pressure from the Australian dollar last week, although it remains in very familiar territory. This week sees a more economic data than last week, which should provide more movement. In New Zealand we have just the NZIER quarterly survey of business opinion due for release on Tuesday. In Australia, Tuesday sees the release of building and trade balance numbers ahead of the RBA monetary policy announcement. The RBA announcement will be followed closely. A movement towards an easing in the cash rate would see the NZD gain back some of last week’s lost ground. Wednesday sees the release of the Australian retail sales numbers, but do not expect too much reaction to these.

NZD/GBP (GBP/NZD)
The NZD saw renewed pressure from the Pound Sterling last week, as all growth assets such as the NZD lost ground. The double credit rating agency downgrade added to the pressure on the NZ dollar. Ironically, further quantitative easing from the BOE is a possibility on Thursday this week, at the BOE monetary policy announcement. If uncertainty in Europe continues to increase, expect the NZD to see further pressure. In NZ we have just the  NZIER quarterly survey of business opinion due for release on Tuesday. Consolidation below .4950 (above GBPNZD 2.0200) remains the key to direction in the medium term. Current levels will start to look attractive for those looking to sell GBP and buy NZD when compared to .5250 (GBPNZD 1.9050) of just two weeks ago. The averaging of transfers by staggering at different levels, should be looked at when considering money transfers.

 
NZD/CAD
The NZ dollar continues to see pressure from the Canadian dollar as this pair retreats from levels above .8350 just one month ago. The significant support level at .7875 remains in place for the time being, a consolidated break down through this level would enable another leg lower from the NZD. This week sees just the NZIER quarterly survey of business opinion due for release on Tuesday in New Zealand. In Canada the calendar is light ahead of Friday when building, manufacturing and employment numbers are due for release.

NZD/RAND
Finally the RAND stopped giving up ground to the NZD last week. The pair was much more stable that in recent weeks, and it saw just a small outperformance by the RAND. Helping curb the NZ dollar strength was the double agency downgrade of the NZ sovereign credit rating, and a stablisation of the South African bond market as the end of the quarter approached. This coming week sees the NZIER quarterly survey of business opinion due for release on Tuesday. In South Africa the retail sales numbers are due for release on Thursday.

NZD/EURO (EURO/NZD)
The NZD continues to see some pressure from the EURO, albeit the NZD has bounced back from the lows it saw following the dual agency NZ sovereign debt credit downgrade. News over the weekend that Greece are struggling to make deficit targets has again hurt the prospects for the EURO. The NZ focus for the week will be the NZIER quarterly survey of business opinion due for release on Tuesday. In Europe, the ECB monetary policy announcement is the focus. The chance of a 50 pt cut to the cash rate has dropped significantly with last week’s higher than expected inflation number, so a 25 pt cut appears to be a done deal. Meanwhile the issues with Greece continue and it appears to be a matter of timing and management of a Greek default in the coming months. Ironically this will keep the pressure on the NZ dollar, as the global growth outlook lowers on this prospect.

 
NZD/YEN (NZD/YEN)
The YEN continued with its dominant recent run over the NZ dollar. The lower global growth outlook has seen the YEN in demand and the NZD under pressure. Current levels represent very good value buying of NZD from a historical perspective. With just the NZIER quarterly survey of business opinion due for release on Tuesday in New Zealand, the lead will come from the wider market appetite for risk for the most part. Intervention from the Bank of Japan to sell YEN remains a proposition, but is unlikely with the USD/JPY at current levels.

AUD/USD
This pair remained volatile last week. This week starts at levels close to where the week started last week. There were periods last week when the AUD managed to make up some ground on the US dollar, but then the risk aversion returned. The focus in Australia this week comes on Tuesday when we have building and trade numbers ahead of the RBA monetary policy announcement. The RBA are expected to leave the cash rate unchanged at 4.75%, but their statement will be closely watched for any change in bias towards an easing in the cash rate in the coming months. In the US there is the usual host of economic numbers, but of most importance are the employment numbers on Friday. A consolidated break of support at .9550, should open up the way for another leg lower from the AUD.

AUD/GBP (GBP/AUD)                            
The AUD lost ground against the Pound Sterling last week, whilst staying within support and resistance levels. This week will be an interesting one for this pair with both respective central banks making monetary policy announcements. First comes the RBA on Wednesday after building and trade balance numbers. The cash rate is expected to remain unchanged at 4.75% at this meeting, but any change in their stoic rhetoric should be reacted to. In the UK there is a host of economic data, but the BOE announcement comes on Thursday. No change to the QE program is expected at this meeting, but that remains the risk. If the global growth profile continues to deteriorate, current levels may well prove to be good levels to purchase Pound Sterling with Australian dollars.

 
AUD/EURO (EURO/AUD)
The AUD remains under relative pressure from the EURO as the global growth profile continues to nosedive. The weekend’s news that Greece is likely to miss deficit targets has seen the AUD bounce from the lows with the .7150 level ( EUROAUD 1.3985) remaining the crucial level of AUD support. This week will prove interesting with both respective central banks in action. The focus starts in Australia with building and trade balance numbers ahead of the RBA announcement. Expect the RBA to maintain its 4.75% cash rate, but the tone of the statement remains the key. After Wednesdays Australian retail sales number it becomes the turn of the ECB on Thursday. A 25pt cut to the cash rate is expected. There was a reasonable chance of a 50 pt cut prior to the higher than expected Euro-zone inflation number on Friday.

GBP/USD
While this pair saw reasonable levels of intraday volatility, the range was relatively subdued last week. The economic data flow returns with a vengeance this week.  Of particular note in the UK will be the BOE monetary policy announcement on Thursday. No change is expected, but the risk is they increase their QE program earlier than expected. In the US the focus will build towards the important employment numbers on Friday. In the lead up to this the lead will no doubt come from general market appetite for risk, or lack of it. The US dollar is being supported at the moment because of grave concerns about European debt and its banking sector, and this is likely to continue.

GBP/EURO (EURO/GBP)
This pair was relatively stable for most of last week before the EURO started to come under intense pressure on Friday. This pressure has continued this week. The higher than expected inflationary pressure was the last thing Europe needed and this has seen the chances of a 50pt cut from the ECB at Thursday’s meeting all but taken out, but a 25pt cut is highly likely. The weekend news that Greece is likely to miss deficit targets has further weighed on the EURO, and it remains likely that we will see some kind of managed default come in the coming months. The BOE also have a monetary policy announcement on Thursday. Although no increase is expected to the QE program at this meeting, an earlier than expected move remains the risk. Expect further moves higher from the GBP from current levels to be harder to make, in the absence of further bad news from Greece.

GBP/RAND
The volatile nature of this pair continued last week, albeit the RAND managed to stem its recent weakness a little. Friday saw higher than expected producer price numbers in South Africa and these have reduced the chances of any further cut to the cash rate from the South African Reserve Bank. Meanwhile this week sees almost the entire focus on the UK side of the pairing. Of note will be the BOE announcement of monetary policy on Thursday. No change is expected at this meeting, but the risk is that they go ahead and expand their QE program earlier than expected. If the global growth profile continues to  deteriorate the pressure may resume on the RAND.

Market commentary:

Throughout last week the market continued its dual focus of the complex debt issues in Europe, and a lower global growth outlook.

The European debt situation remains tense as news emerged over the weekend that Greece will most probably miss deficit targets in 2011.

The ECB, EU and IMF 'Troika' are back in Athens to make their assessments on whether or not to release the next 8 billion Euro in bailout funds. This news will not be greatly received by the markets.

The prospect of the increased deficit means the chances of default have increased and the pressure on the wider European banking sector again increases. To put this in context, the cost of insuring European debt is fast approaching levels seen at the peak of the global financial crisis in 2008.

This increased risk premium is being felt across the globe in funding markets.

It will have the wider implication of curbing growth through increased funding costs. An illustration of this is the double downgrade of New Zealand sovereign credit rating by agencies Fitch and S&P.

So overall risk aversion remains in place, commodity and equity prices are again being pushed lower, and demand for US dollars and US Treasury debt remains high.

In New Zealand there was little in the way of top tier economic data last week. The NBNZ Business Confidence survey softened, but this was to be expected given the recent gloomy outlook for the global economy. Undoubtedly the biggest news came in the form of the credit rating downgrades for NZ sovereign debt. This saw the NZ dollar lose across the board as one would expect. The material impact of these downgrades will not be too significant in the short term. The fact that interbank lending rates did not materially change immediately is an encouraging sign, for the time being at least. The coming week is again light on economic data, with just the quarterly release of business opinion from the NZ Institute of Economic Research due on Tuesday.

There was little news of note in Australia last week. Most of the lead for the Australian dollar was provided by external forces. Mixed economic news from the closely aligned Chinese economy did not provide clarity, but the weakening  basket of global commodities ensured that any attempt at resurgence by the Australian dollar was short lived for the most part. This week sees a more active economic calendar. Tuesday sees the release of the last building and trade balance statistics ahead of the Reserve Bank of Australia (RBA) announcement on monetary policy. The RBA are widely tipped to leave the cash rate unchanged at 4.75%. But given the crumbling global outlook and increased uncertainty, expect some kind of change to their rhetoric, which has remained stoic on inflationary pressure, much to the contrary of interest rate market pricing. Friday sees the monthly release of the retail sales numbers. These will be watched, but expect limited reaction to this number.

In the US some economic data last week was positive. Better than expected housing and weekly jobless claims, coupled with upward revisions to GDP and consumer sentiment surveys, meant the picture was relatively rosy, even if the equity markets did not reflect this. There is certainly a lessening argument for further quantitative easing (QE – basically the electronic printing of money in an attempt to stimulate growth) from the Federal Reserve (FED), and this fact is being reflected in the continuing strength of the US dollar. This week sees the usual slurry of economic data releases in the US. Tuesday sees manufacturing PMI numbers released. Wednesday FED Chairman Bernanke testifies to the Joint Economic Committee in Washington on the state of the economy. Wednesday sees non-manufacturing PMI numbers released ahead of the all important unemployment numbers on Thursday. The market expects the unemployment rate to remain at 9.1% with 51,000 jobs being created.

In Europe focus remains intense on the debt situation. Complicating matters was the release of the initial inflation number for the Euro-zone on Friday. It came out at 3.0% and decreases the chances of a 50 pt cut in the cash rate from the European Central Bank (ECB), when they announce their monetary policy on Thursday. Certainly a 25 pt cut to the cash rate is a foregone conclusion, but the economy would benefit from a further 25 pts immediately. The issue comes with the ECB’s sole mandate for price stability, even if the inflationary pressure is likely to fall back in the coming months. Apart from the build up to the ECB, much of the attention will be on Athens and any further headlines that emerge from the Troika meetings. Further bank capitalization is urgently needed in Europe ahead of any managed default on bonds by Greece. It will take time to arrange the vehicle for bank recapitalization and this is why it is so importantly that this next tranche of bailout funds be extended to Greece.

In the UK there was very little in the way of economic data last week. Statements from various members of the Bank of England’s (BOE) monetary policy committee seem to confirm that further QE would be embarked upon in the coming months. This week’s BOE monetary policy announcement may prove to be too soon, but the chance of an extension to the 200 billion GBP program is a possibility on Thursday. Before this we have a host of manufacturing, housing and construction numbers, along with the final GDP release. The market expects around 75 billion further in efforts over the next couple of meetings to be announced and around a further 150 billion in total. This has already been priced into the GBP for the most part, so the actual announcement is not expected to greatly soften the beleaguered Pound Sterling further.

In Canada the economic data flow last week was also light. Just monthly GDP numbers on Friday revealed expected growth of +.3%. Overall the Canadian dollar has been under pressure as the commodity markets have faulted with the global growth outlook. This week sees Friday as the focus. Building, manufacturing and employment numbers are released progressively throughout the day. The better than expected US economic data last week has seen the CAD put renewed pressure on the NZ and Australian dollars.

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