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Markets to and fro over the expected timing of Fed QE ‘tapering’ and investors will seek clarity from Bernanke's testimony this week

Currencies
Markets to and fro over the expected timing of Fed QE ‘tapering’ and investors will seek clarity from Bernanke's testimony this week

by Mike Jones

It was another wild ride in the NZD last week, one that eventually amounted to little. After climbing to almost 0.7960, the NZD/USD slipped back to finish the week mid-range at around 0.7780.

Most of this volatility was driven off gyrations in USD sentiment, as markets to’ed and fro’ed over the expected timing of Fed QE ‘tapering’.

We can expect more of the same this week, with Bernanke’s mid-week testimony and a bunch of US data set to again test the market’s expectation tapering will begin in September.

Developments in US fixed income markets remain the key near-term driver of the NZD/USD. But local fundamentals remain highly supportive of the currency.

Last week’s NZ economic data painted a picture of an upbeat business community, a strong housing market, and an expanding manufacturing sector. NZ-US 3-year swap differentials continue to hold up around 265bps, a level that usually coincides with a NZD/USD above 0.8000.

We remain of the view that additional steep falls in the NZD/USD are unlikely, with the currency more likely to spend the remainder of the year in a sideways, to slightly higher, range.

For this week, Q2 CPI is the most notable piece of local event risk facing the currency. Another weak inflation number is expected (BNZ and market both 0.3%q/q, 0.8%y/y). 

Confirmation of another CPI print below the RBNZ’s 1-3% target band may encourage OIS markets to trim the 50bps worth of hikes now priced into the curve, weighing on the NZD.

Stubbornly strong commodity prices remain a fundamental support for the NZD, particularly against the AUD.

While we have been expecting some easing in prices, ongoing supply tightness in soft commodity markets (dairy, kiwifruit, meat) mean we may have to upgrade our view before long. Wednesday morning’s GDT dairy auction will be a key test of this.

The NZD/AUD leapt to another 5-year high on Friday, this time above 0.8630. We think the climb has further to run as economic fundamentals move in favour of a higher cross.

The ‘fair-value’ range of our short-term NZD/AUD valuation model (based on commodity prices, relative business confidence, and interest rates differentials) has shifted up to 0.8300-0.8500.

For today, Chinese GDP data at 2pm (NZT) will set the tone for the NZD. A slowing to 7.5%y/y is expected.

However, suggestions from the Chinese administration that China could tolerate 6.5%-7.0% may have set ‘true’ expectations a little lower. The AUD remains the most sensitive currency to downside surprises on Chinese growth, with the NZD not far behind.

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Majors

Friday’s offshore session was all about consolidation in relatively thin trading conditions. The USD managed to eke out small gains against most of the major currencies.

On the face of it, a strong set of US PPIs (2.5%y/y vs. 2.1% expected) and buoyant consumer confidence appeared to be behind the USD move. But the gains just as likely reflect the reestablishment of speculative long positions in the USD following the mid-week flush out.

The latest IMM data shows USD long positioning was built back up to near the recent highs as of last Tuesday. This helps explain the violent ‘sell USD’ reaction to Bernanke’s dovish message on Wednesday.

The EUR/USD was one of the bigger casualties of Friday’s improved USD sentiment, sliding from 1.3100 to almost 1.3000.

Fitch’s slashing of France’s sovereign credit rating from AAA to AA+ was mostly to blame here, even if it was just following earlier ratings adjustments by Moody’s and S&P.

Still, the AUD was once again the weakest link, falling around a cent to fresh 3-year lows close to 0.9000.

Fed tapering expectations remain the key driver of the USD and currency markets. From this perspective, Fed Chairman Bernanke’s semi-annual testimony to Congress (Thursday) promises to be this week’s main event.

Investors will be looking for even more clarity on the expected timing of QE tapering. A slew of important US data (retail sales, empire manufacturing, CPI, and housing starts) will provide the curtain raiser to the Bernanke main event.

Any support from either the data or Bernanke for the market’s (and our) expectation tapering will commence in September will likely add support to the USD rally.

Outside of the US, it is a busy week for central bank minutes (BoJ, BoE, and RBA). The RBA Board minutes on Tuesday are likely to restate the Bank’s easing bias and preference for a lower AUD.

Meanwhile, there will be heightened attention on the voter split of the Bank of England minutes (the first under new Governor Carney). We expect an unchanged split.

Rates are expected to be left unchanged at 1% at Thursday’s Bank of Canada meeting. Important for the CAD will be whether the BoC retains its (mild) hawkish bias under new Governor Poloz.

Event Calendar:

15 July: NZ PSI; UK house prices; CH GDP, industrial production, & retail sales;

16 July: NZ CPI; AU RBA minutes; UK CPI; EU German ZEW; US CPI; US industrial production; US NAHB housing index;

17 July: JN BoJ minutes; UK BoE minutes; UK ILO unemployment; US housing starts & building permits; CA Bank of Canada announcement;

18 July: G20 begins; NZ ANZ consumer confidence; UK retail sales; US Fed’s Bernanke begins Testimony to Congress;

19 July: NZ net migration; NZ credit card billings; UK public sector borrowing.

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