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Good news, bad news: Italy and Spain hit by credit downgrades, US payrolls surprise on upside

Good news, bad news: Italy and Spain hit by credit downgrades, US payrolls surprise on upside

By Mike Burrrowes and Kymberly Martin


The NZD’s fortunes were mixed on Friday night. NZD/USD reached an intra-day high just below 0.7800 after better-than-expected US data (see below). However, the gains were short-lived after sovereign downgrades to Italy and Spain served to dampen risk sentiment. NZD/USD is currently trading just above 0.7700.

Trading on the NZD crosses was mixed as well. NZD/EUR fell below 0.5730, before recovering late Saturday morning to above 0.5750. Expect trading on this cross to remain volatile as the European debt crisis remains far from resolved.  NZD/GBP dribbled lower throughout the evening, falling from just above 0.5000 to 0.4950 currently.

The NZD lost ground relative to the AUD, falling from around 0.7900 to 0.7870. Our NZD/AUD “fair value” range has fallen slightly over the past week, as the NZ-AU 3-year interest rate differential moved to -94bps from -90bps. The implied “fair value” range is 0.7690 to 0.7890.

Our NZD/USD “fair value” model continues to highlight some near-term downside risks to the currency. The “fair value” range is currently 0.7080 to 0.7280.

The data week kicks off on Tuesday with NZ electronic card transactions for September. Despite signs of a very sharp increase in spending early in the month as the Rugby World Cup started, for the month overall spending looks to have only posted a moderate rebound from August’s dip, rather than a big spike.

Tuesday also sees the release of the full 2010/11 fiscal year accounts that should confirm a record budget deficit, but also highlight the still relatively strong position of the NZ government relative to other OECD nations, debt wise.


Rating downgrades of Italy and Spain has kept the focus on Europe, despite some strong US data. Escalating concerns over Europe saw risk aversion rise and the USD remain well supported.

Risk sentiment improved early Saturday morning after the release of better-than-expected US non-farm payrolls for September (103k vs. 60k). Following the data, the USD index fell 0.5% to 78.00 as investors moved into higher-yielding currencies.

The improvement in sentiment was short-lived after Fitch cut the ratings of Italy and Spain. Fitch noted concerns they will struggle to improve their finances as Europe’s debt crisis intensifies (see Fixed Interest section below). Adding to Europe’s woes, Moody’s placed Belgium on review for a possible downgrade.

Following the downgrades, EUR/USD nose-dived from around 1.3500 to an intra-day low near 1.3360. The currency is currently trading at 1.3380.

The focus is likely to remain on Europe as we begin the week with German Chancellor Merkel and French President Sarkozy meeting in an attempt to find common ground on recapitalising European banks and the operation of the EFSF in the sovereign bond market. The first reports from this meeting are that a response to the crisis will be delivered at the November 3rd G20 meeting.  

GBP/USD bucked the trend on Friday, rising from 1.5460 to 1.5550 currently. After the surprise quantitative easing announcement from the Bank of England on Thursday evening, the move higher has caught many off-guard. It seems some paring of short-positions and perceived safety of UK banks (relative to European banks) helped support the currency.

The risk sensitive AUD, CAD and NZD were mixed on Friday. AUD/USD popped from 0.9790 to just below 0.9880 following US non-farm payrolls. These gains were reversed following the ratings downgrades of Italy and Spain. AUD/USD is currently trading at 0.9790.

Looking to the week ahead, expect trading to be dominated by headlines from various European leaders. On the data front, the highlights in Europe will be Eurozone industrial production on Wednesday, and Eurozone CPI and the trade balance on Friday. In the US, the release of the FOMC minutes will garner some attention on Wednesday morning. There are also several Federal Reserve members speaking throughout the week.    

Fixed Interest Markets

NZ yields moved higher across the curve. On Friday night US and German 10-year yields gapped higher after a positive surprise on US payroll data.

NZ bond yields inched higher by 4bps across the curve on Friday.  The yield on 21s is now at 4.46%. Australian 10-year yields have also risen in recent days, reducing the NZ-AU 10-year bond spread to 20bps.

NZ swap yields crept up taking 10-year swap yields 6bps higher to 4.49%. 2-year yields rose 4bps to end the week at 3.09%. The market has revised OCR hike expectations to around 25bps for the coming year. The market had previously almost removed any expectations of rate hikes. Some definite announcement on coordinated action in the European debt crisis, along with continued solid domestic data will be required for markets to revise expectations higher from here.

On Friday night, US 10-year yields gapped higher from 2.00% to 2.12% after the release of better-than-expected non-farm payrolls data. (103K vs. 60K expected). Yields then bobbed around to end the week at 2.08%, their highest level in three weeks. German 10-year yields followed the same pattern gapping from 1.94% to 2.03% before closing around 2.00%.

There were further downgrades to European sovereign ratings on Friday by rating agency Fitch. Italy was downgraded to A+ with negative outlook from AA-. Other agency ratings were already lower, so the market reaction was minimal. In addition, the ECB continued to buy Italian bonds last week keeping their 10-year yield stable around 5.5%. Fitch also downgraded Spain’s rating to AA- with negative outlook from AA+.

This takes the rating a notch below competitor ratings. Spanish CDS spreads (a measure of default risk) ticked up after the announcement, but at 369bps still trade well below their peak.

It is a week of mostly 2nd tier NZ data ahead. Local yields will continue to take their cue from off-shore developments. On Friday, US equities declined into the close, to end down 0.80% on the day, as risk appetite faded.

Therefore, upward pressure to NZ yields today, from Friday’s rise in US yields, may be limited.

There are no NZ data releases today. Expect NZ yields to continue to be boosted by better global sentiment overnight and rises in offshore yields.

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

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

All its research is available here.

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