Rising peripheral bond spreads remain a headwind for the EUR

by Mike Jones

NZD

The NZD/USD has spent the past 24 hours quietly consolidating in the familiar 0.7880-0.7920 range. Range-trading remains the norm across global markets as all and sundry await the EU Summit.

While NZD/USD remains trapped in a range, NZD/EUR has continued to climb. The cross made a fresh 4-month high of nearly 0.6350 overnight as Spanish sovereign solvency worries continue to take a toll on EUR sentiment. Providing additional headwinds for the EUR, investors are now (rightly) a little less confident we’ll get any decisive policy action from the EU Summit beginning tonight.

Yesterday’s merchandise trade data has probably helped shore up NZD demand over the past 24 hours. The sheer resilience of exports and imports certainly supports the notion last week’s stellar Q1 GDP figures were not just a flash in the pan, as others have argued. The numbers imply annual growth in export and import volumes of about 4.5% and 5.5% respectively for Q2.

This afternoon’s (1pm NZT) NBNZ business survey is rarely market moving, but it is one of the better forward indicators of NZ economic activity. We’re expecting business confidence to soften (on Europe fears) but for own-activity indicators to hold up at reasonably robust levels. We’d have to see these indicators fall precipitously to call into question our forecast for 2.6%y/y growth for the 2012 calendar year.

Ahead of tonight’ Summit, we suspect the familiar 0.7845-0.7945 range will continue to contain the NZD/USD. As we’ve noted previously (for example here), the risk of disappointment from the Summit is high.

Admittedly, investors have reeled in their expectations a little over the past few days. But a failure by European politicians to take decisive action would still likely see some near-term paring of risk appetite, and a pull-back in pro-cyclical currencies like the NZD and AUD. A slide back through 0.7800 is possible on NZD/USD, but solid support is eyed at 0.7670.

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Majors

Currency markets remain in a holding pattern as investors await tonight’s EU Summit. Range-trading is still the dominant theme across markets, albeit with the USD finding some modest support.

Selling of EUR/USD and EUR crosses was again a feature of the overnight session, as investors continued to pare expectations of aggressive policy action from the tonight’s Summit. The EUR/USD edged down to 1.2460 in unconvincing fashion, helped by more AUD/EUR and NZD/EUR buying.

Rising peripheral bond spreads remain a headwind for the EUR. There was no respite on this front overnight, with 10-year Spanish yields creeping up to 6.9% - dangerously close to the 7% ‘bailout zone’.

Nonetheless, despite persistent European negativity, broader market sentiment held up relatively well thanks to some encouraging US data. Stronger than expected US home sales and durable goods orders helped alleviate fears the US economic recovery is losing steam.

European and US equity markets finished the night well into the black (gains of 0.7-1.8%), and the CRB commodity price index climbed 0.9%. Oil prices rose 1.2% to US$80/barrel. Against this backdrop, the ‘risk-sensitive’ NZD and AUD outperformed once more, holding up well despite the strengthening USD.

It’s worth noting, markets have trimmed their expectations of what to expect from the EU Summit beginning tonight (ending Friday or possibly sometime over the weekend). This means there may be less fallout on risk assets and the EUR in the event the Summit turns out to be just another talk fest.

In particular, Germany has continued to resist the idea of Eurobonds (in the absence of setting up national spending controls). There does appear to be some prospect of a deal on banking supervision though, and Germany is softening its stance on the €500b ESM being used for direct bank recapitalisation. So markets are still holding out for some policy action. In the event politicians disappoint, expect some near-term paring of risk appetite and a re-test of EUR/USD lows around 1.2360.

Other news: US durable goods orders rise 1.1% (0.5% expected) with the ex-non defence aircraft figure even higher at 1.6%. US pending home sales increase 5.9%m/m (15.3%y/y), against expectations of +1.5%. UK CBI retail sales report for June showed headline sales at 43 (15 forecast), thanks to stronger Queen’s Jubilee sales. GE CPI 1.7%y/y (1.8% expected).

Event Calendar:
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.