Chinese authorities happy with the strength of their economy

by Mike Jones

NZD

The NZD/USD spent most of last week trading choppily within the familiar 0.8120-0.8290 range. The currency was whipped around by see-sawing risk sentiment, as fears about the strength of global activity waxed and waned.

Markets finished the week on a sombre note. Not only did Friday’s collection of Chinese data disappoint (GDP expanded ‘just’ 8.1% vs. expectations of 8.4%), but worries about the European periphery are ramping up again.

Doubts about Spain’s ability to deliver a 3% deficit-to-GDP ratio in 2013 saw Spanish 10-year bond yields push up to nearly 6% on Friday.

Global equity markets ended the week well into the red (the Eurostoxx 50 fell 2.6%), and our risk appetite index (scale 0-100%) finished up at 55.3% – a 1½ month low. Rising risk aversion and heightened investor nervousness saw the ‘safe-haven’ USD and JPY outperform last week.

However, solid Australian and NZ data helped insulate the antipodean currencies from USD strength. March Australian employment data blew analyst expectations out of the water, while the NZ QSBO and PMI surveys told of an economy that remains in good heart, overall. So while the NZD broadly held its own against the USD last week, most of the NZD cross rates tracked higher.

NZD/EUR hit 2-month highs above 0.6300 and NZD/GBP rose to a one-month high above 0.5200. We expect to see further gains in both these currency pairs in coming months.

Thursday’s Q1 CPI will be the big news of this NZ data week. There is a good chance it will look tepid, aided by the general heights of the NZ dollar.

We are picking a 0.5% advance, which would further clip annual headline inflation, to 1.6%, from 1.8%. The market is looking for a 0.6% gain in the Q1 CPI and the RBNZ 0.7%. Note that there might be some last-minute fine-tuning from today’s Food Price Index (we are picking 0.2% (1.4% y/y) for this).

Whatever the local news, we expect offshore trends in risk appetite and global equity market sentiment to drive direction in the NZD this week. All eyes globally are back on Europe. So even if we see more robust US data, risk appetite will suffer if Spanish concerns linger.

The NZD/USD remains ‘overvalued’ according to our short-term valuation model, increasing the downside vulnerability of the currency. A convincing NZD/USD break below 0.8150 would pave the way for a test of key support at 0.8090 (the 200-day moving average).

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Majors

Over the weekend, China widened the daily trading band of the USD/CNY from 0.5% to 1.0%. The PBOC will continue to set the midpoint of this band on a daily basis.

While the timing may have caught a few analysts off- guard, the move was expected to the extent that China has already said it will gradually take steps to liberalise the renminbi. The ultimate aim is to achieve a freely-floating currency, although this is definitely a long-term goal.

What does it mean? First, the widening of the band paves the way for greater CNY appreciation in future (the CNY is still undervalued). This is desirable from the perspective of the global economy. A stronger CNY will help rebalance Chinese demand away from exports towards domestic demand.

A stronger CNY also implies less Chinese reserve accumulation, fewer US bond purchases, and less reserves recycling from USDs into EUR, JPY, GBP and AUD.Second, the move tends to suggest Chinese authorities are broadly happy with the strength of their economy and the ability of Chinese exporters to cope with a stronger currency.

This may help assuage recent fears about a ‘hard-landing’ for the Chinese economy, thus supporting commodity prices and ‘risk-sensitive’ currencies like the AUD and NZD.

Dark clouds appear to be forming over the EUR again. Indeed, Friday night’s trading was dominated by rising European sovereign debt fears. News Spanish banks borrowed a record €316b from the ECB in March send markets into a tailspin. Spanish bond yields soared, European stocks were slammed and the EUR underperformed.

For this week, we expect markets’ focus to remain firmly on Europe. Spanish debt auctions on Tuesday and Thursday will be closely watched. Any evidence of waning demand for Spanish debt would see a heavy toll taken on the EUR. This week’s German ZEW (Tuesday) and IFO (Friday) data should be fairly solid. But, in an environment of risk aversion, this may not be enough to prop up the EUR.

There is also plenty of data and events to watch in the US this week. Friday’s IMF meeting in Washington will likely see increased pressure on the Eurozone to increase the size of its firewall, but this is likely to be resisted for now.

On the data front, there is US retail sales, industrial production and some regional Fed manufacturing indices to keep an eye on.  More evidence of building US economic momentum would support the USD, and add to the headwinds facing the EUR/USD.

All its research is available here.