EU summit leaders preparing investors for further disappointment

by Mike Jones

NZD

The NZD/USD lost a bit more of its lustre overnight as risk aversion cast a pall over markets. However, the NZD continues to outperform most of its ‘risk-sensitive’ peers, reflecting solid domestic fundamentals.

We’ve been suggesting markets had become a little optimistic on the chances of decisive policy action from this week’s EU Summit. Overnight, cold reality began to dawn on markets. Risk sentiment suffered as European policy makers prepared markets for disappointment. Global equity markets are a sea of red, bond yields re lower, and our risk appetite index (scale 0-100%) slipped from 56.6% to 50.5%.

In currency markets, the general ‘risk off’ sentiment was reflected in widespread JPY buying. Against the broadly stronger JPY, the NZD/JPY was knocked from 63.50 to almost 62.50, helping drag the NZD/USD back below 0.7900.

Still, the NZD/AUD continued to grind its way higher. At 0.7870, the cross is now almost 3% above its May lows.

We expect further gradual appreciation this year as NZ-AU growth and interest rate differentials continue to move in favour of the NZD. Following last week’s bumper NZ GDP figures, NZ-AU 3-year swap differentials have pushed up to -40bps – the highest level since June 2010.

Plugging these into our short-term NZD/AUD valuation model (which is based on NZ-AU interest rate differentials, relative business confidence and commodity prices) yields a ‘fair-value’ range of 0.7900-0.8100. This suggests support at 0.7840 should hold in the near-term.

There is little in the way of data or events in NZ or Australia to influence NZD sentiment today.

A speech from RBA assistant governor Debelle may garner a few headlines around 4pm (NZT). Instead, gyrations in offshore risk sentiment will continue to drive the NZD.

Keep an eye on Asian equity markets today for clues in this regard.

------------------------------------------------------------------------------------------------------------------------------------------

To subscribe to our free daily Currency Rate Sheet and News email, enter your email address here.

------------------------------------------------------------------------------------------------------------------------------------------

Majors

The ‘safe-haven’ USD and JPY outperformed overnight as investor nerves began to fray ahead of Thursday’s EU Summit.

Investors have started the week in a generally risk averse frame of mind. Markets are slowly facing up to the fact that this week’s Summit is unlikely to deliver a panacea for Europe’s problems.

Policy makers are now clearly trying to manage expectations in this regard. Overnight, German Chancellor Merkel said she is worried people are hoping for “easy solutions” and the ECB’s Nowotny said “don’t expected too much” from the Summit.

The reaction in markets was indicative of the extent to which extra stimulus and policy action has been priced in of late. 

European equity markets are down 1.1-3.7% with the S&P500 is currently around 1.5% lower. Bond yields are falling and risk aversion gauges like the VIX are pressing higher.

Announcements that Spain has formally applied for more cash for its banks and Cyprus has requested a sovereign bailout were not unexpected, but certainly underscored the generally ‘risk-off’ mood.

Against this backdrop, the EUR continued on its journey southwards as investors piled back into the ‘safe-haven’ USD and JPY. Heavy selling of JPY crosses, amid chatter of strong demand from Japanese exporters, further weighed on the EUR, AUD, and CAD.

The AUD/JPY and EUR/JPY both lost around 1.5%, dragging the AUD/USD back below parity, and EUR/USD from above 1.2550 to 1.2500.

For today, we suspect risk sensitive currencies will remain heavy as investors continue to revise lower their expectations for Thursday’s Summit. Bounces towards 1.0040 in AUD/USD and 1.2535 in EUR/USD should attract sellers.

There is relatively little on the data calendar so expect Asian equity market sentiment to provide direction in the first instance.

Other news: Chicago Fed Index -0.45 (-0.3 expected). Dallas Fed (manufacturing) index 5.8, well above market expectations of -2.0. US new home sales 369k vs. 347k expected.

Event Calendar:
26 June: RBA’s Debelle speaking; UK public borrowing; US Richmond Fed index; US consumer confidence; SP budget balance; Italy sells bonds; 27 June: NZ trade balance; GE CPI; US durable goods orders; US pending home sales; 28 June: NZ business confidence; JP retail trade; AU home sales; GE unemployment; UK & US final Q1 GDP; UK Q1 current account; US jobless claims; IT bond auction; EU leaders Summit kicks off; Fed’s Pianalto speaks; 29 June: NZ building permits; JN jobless rate, CPI, industrial production; EU CPI; US personal spending; US Fed’s Bullard speaking; US Chicago PMI; 1 July: CH manufacturing PMI; 5 July: ECB.

All its research is available here.