Talk of yen intervention the highlight in currency markets

By Mike Jones

The NZD has continued to dribble lower over the past 24 hours, thanks to an eroding yield advantage and further deterioration in investors’ risk appetite. NZD/USD slipped to a 7-week low of almost 0.6960 overnight. Early in the night, the NZD found support from an apparent brightening in the global outlook.

The German IFO index certainly contained some welcome good news. The headline business sentiment index surged to three year highs, propelling EUR/USD from 1.2650 to above 1.2700. The NZD/USD was dragged higher in its wake, to an overnight high of 0.7060.

However, gloom descended over markets later in the night. Fears about a double dip global recession returned to the fore following more shocking US economic data and heightened European sovereign debt jitters. US new home sales plunged 12.4%m/m in July and European sovereign credit spreads widened across the board. With appetite for risk coming under further pressure, investors trimmed positions in “growth-sensitive” currencies like the NZD and NZD/USD soon found itself below 0.7000 for the first time since early July.

Further erosion of the NZD’s yield advantage has also weighed on the currency over the past 24 hours. In fact, NZ-US 3-year swap spreads dived 10bps yesterday to 4-month lows around 290bps. Plugging this into our short-term valuation model yields a NZD/USD “fair-value” range of 0.6900-0.7100. This underscores our view that bounces in the NZD/USD towards 0.7100 will be short-lived in the short-term, with a move further to the downside the bigger risk in coming sessions.

With the local data calendar bare, we suspect the NZD will continue to take its cues from offshore for the rest of this week. Technically speaking, a daily close below 0.7000 would pave the way for a deeper correction towards 0.6850.

Majors

Movements in the major currencies were mixed overnight. While poor US data again weighed on the USD, renewed “safe-haven” demand and a sliding JPY provided some offset. As a result, the USD index simply see-sawed inside a 82.90-83.50 range for most of the night. Japanese policy makers finally gained some traction over the soaring JPY yesterday, reigning in the plunging USD/JPY.

Not only did Japanese PM Kan say there was a “sense of crisis” over the strong JPY, but Finance Minister Noda said he would respond “appropriately” – the first hint intervention to stem the JPY’s rise could be in the offing. Nervous investors trimmed JPY long positions, pitching USD/JPY from 84.00 to almost 84.70. Widespread selling of JPY crosses was also noted – EUR/JPY, GBP/JPY and AUD/JPY all bounced off their recent lows. Along with EUR/JPY buying, more encouraging European data bolstered the EUR early in the night.

The German IFO survey impressed, with the business climate index rising to 106.7 in August (105.7 expected) – the highest in three years. The scramble to cover EUR shorts in the wake of the data saw EUR/USD jump from 1.2650 to almost 1.2720. However, the gains proved fleeting with escalating sovereign debt concerns later pressuring the single-currency back below 1.2700. Irish 5-year CDS spreads (a proxy for default probability) widened out to 17-month highs above 310bps following yesterday’s Irish downgrade (to AA- by S&P, from AA) and Greek-German 10-year bond spreads blew out 40bps to 925bps.

Last night’s US data was all bad. Both durable goods orders (0.3%m/m vs. 3.0% expected) and new home sales (-12.4%m/m vs. flat expected) undershot expectations by a clear margin in July, suggesting momentum in the US housing and manufacturing sectors has all but disappeared. Still, market reaction was surprisingly muted, suggesting some weakness had already been factored in following yesterday’s awful existing home sales figures. US stocks scraped into the black, after a weak lead from Europe (the S&P500 is currently up 0.4%).

And, in a sign the recent rally may be beginning to run out of steam, US Treasury yields actually rose, to finish the night 4-5bps higher. A 5-year US$36b bond auction drew a higher-than-expected yield, which may have contributed. Looking ahead, we wouldn’t be surprised to see more consolidation amongst the major currencies in the lead up to this week’s main events – the second estimate of Q2 US GDP and Fed chairman Bernanke’s Jackson Hole address.

* Mike Jones is part of the BNZ research team. 

All its research is available here.