Relief and surprise swept across markets sending equities and commodities substantially higher

by Mike Jones

NZD

After spending most of last week in a tight 0.7840-0.7950 range, the NZD/USD roared higher at the conclusion of the EU Summit on Friday.

Against all expectations (including our own), European leaders finally grasped the mettle and announced a series of bold crisis-fighting measures (see Other News for details). A mixture of relief and surprise swept across markets, emboldening investors’ appetite for ‘risky’ assets. Indicative of such, our risk appetite index (scale 0-100%) leapt a full 10 percentage points to 60.4%. Equity markets soared and the CRB global commodity price index rose 4.5% (in part thanks to a near 10% increase in oil prices).

Against a backdrop of surging risk appetite and rising commodity prices, the NZD/USD was propelled from 0.7850 to 2-month highs above 0.8000. NZD/JPY climbed nearly two figures to 64.00. In contrast, NZD/AUD slipped back to 0.7850 as the more ‘risk-sensitive’ AUD outperformed.

In time, the optimism stemming from Friday’s EU announcement may begin to fade. Indeed, the euro-sceptics have already begun to surface with PIMCO’s El Erian suggesting over the weekend the EUR rally will be short-lived. However, for this week, more central bank stimulus looks set to keep the risk rally alive.

Both the Bank of England and ECB are expected to ease policy (see Majors). And any weakness in Friday’s all important US labour market figures would likely to taken as a green light for more quantitative easing from the Federal Reserve.

Yes, the global economy is slowing, but global policy easing can still provide some near-term comfort. As a result, we doubt NZD/USD dips below 0.7950 will be sustained this week. A push towards 0.8100 appears to be the bigger risk, absent a major meltdown in global equity markets.

For NZ, this week looks relatively quiet. Tuesday’s ANZ Commodity Export Price Index could well stabilise, even bounce a little, in world-currency terms, but will be countered by the higher NZ dollar during June. Meanwhile, Wednesday morning’s dairy auction will be another test of the “robust dairy-market dynamics” versus “global worries” debate. Following the last two positive auctions, this one could go either way.

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Majors

After spending most of the week dampening down expectations, European leaders pulled out all the stops at Friday’s EU Summit. A series of bold steps were announced in an effort to shore up sovereign debt markets and bolster European growth.

Essentially, investors got everything on their ‘wish-list’ and then some. The consequent massive boost to risk appetite saw the EUR and ‘risk-sensitive’ assets rocket higher. Admittedly, the reaction was exaggerated by the extent of bearish expectations pervading prior to the deal.

From below 1.2450, the EUR/USD soared to 1.2600 and European and US stock indices notched up gains of 1.5-4.5%. As positive sentiment swirled, an additional round of EUR buying in the New York session saw the single-currency settle above 1.2650. Most of the other majors were dragged higher in the EUR’s wake. The AUD eventually took the lead, finishing the week nearly 2 cents higher around 1.0250.

Looking ahead, risk appetite looks set to remain on the ascendancy early in the week. The weekend’s Chinese PMI fell to the lowest level since November but still managed to beat analyst expectations (50.2 vs. 49.9) and hold above the all important 50 level.  This should help assuage, for now, lingering fears of a Chinese hard landing.

Investors are also hopeful this week’s slew of central bank meetings will deliver more stimulus. The RBA tomorrow should keep rates unchanged at 3.5% but remain on an easing bias. In contrast, we expect the Bank of England (Thursday) to lower rates 25bps to 0.25% and increase asset purchases £50b to £375b. The GBP should remain on the defensive leading up to the BoE decision.

Some combination of easing measures is also expected from the ECB (Thursday). Currently, we expect just a 25bps rate cut. But there is some chance of more (50bps) as well as the announcement of extra liquidity measures (such as another LTRO). In any case, the key question is how the EUR reacts. While easier monetary policy is usually bad news for a currency, we suspect ECB easing would actually support the EUR as investors play up the ‘pro-growth’ implications.

It’s a busy week for US data, even with Wednesday’s holiday. Focus initially will be on Tuesday’s ISM manufacturing index. A modest slowing is expected. Later in the week attention will turn to Friday’s non-farm payrolls release. Given the Fed’s renewed focus on the labour market, the strength of this report will be important in gauging the chances of additional Fed easing.

Other news: EU Summit measures –  €120b ‘growth pact’; bailout funds allowed to recapitalise banks directly; ESM loans to Spanish banks will not have seniority; Spain and Italy will have direct access to bailout facilities; various steps toward banking union.

Event Calendar:
2 July: JP Tankan; EU final manufacturing PMI; US Fed’s Williams speaks; CH HSBC manufacturing index; UK PMI; 3 July: US ISM index; NZ commodity prices; AU RBA meeting; CH non-manufacturing PMI; US factory orders; 4 July: NZ dairy auction; SW Riksbank meeting; EU final services PMI; US Independence Day; IT budget; UK services PMI; 5 July: ECB meeting; EU Draghi press conference; SP debt auction; UK BoE meeting; US ADP employment; US jobless claims; US non-manufacturing ISM; 5 July: NZ Crown Accounts; US non-farm payrolls; UK PPIs.

All its research is available here.