By Mike Jones
The NZD was one of the strongest performing currencies last week. Not only did upbeat global data bolster investors’ risk appetite, but local markets factored in slightly more RBNZ tightening over the next 12 months.
As a result, NZD/USD climbed from below 0.7200 to 1-month highs of nearly 0.7300. Last week’s gains in the NZD came despite a lacklustre performance by most of the major currencies and a mild strengthening in the USD.
The EUR was weighed down by renewed European banking sector fears and GBP struggled amid generally disappointing UK economic data. As a result, NZD/EUR and NZD/GBP were propelled to 2½ and 1½ month highs respectively. On a trade-weighted basis, the NZD lifted 1.3% over the week. Looking ahead, developments over the weekend are likely to keep investors’ appetite for risk well supported early this week, limiting the downside in “growth-sensitive” currencies like the NZD/USD.
Most notably, Saturday’s slew of Chinese data showed economic growth has begun to stabilise, after a wobbly start to the September quarter. Over the past few weeks, gyrations in offshore risk appetite have been the key driver of the NZD. Indeed, the one-month rolling correlation between NZD/USD and the S&P500 increased to around 94% last week, from an average of 67% in June and July. However, for this week, local developments look set to take on added importance. T
hursday’s RBNZ MPS will take centre stage in this regard. We suspect last week’s Canterbury earthquake is the final straw against lifting the OCR any further for the meantime. Yet the RBNZ also has an important job to do in soberly assessing the GDP and, especially, inflation consequences. On the latter, the Bank can’t be complacent. We’ll also be on the lookout for more hand-wringing from Governor Bollard about the recent strengthening in the NZD.
If the RBNZ thought the high NZD was “inconsistent with NZ’s economic outlook” in July, they will almost certainly have retained their view given the now even softer domestic economy. According to our short-term valuation model, the NZD/USD is not yet “overvalued”. In fact, the NZD is smack in the middle of the model’s estimated 0.7200-0.7400 “fair-value” range.
This suggests any dips in NZD/USD below 0.7200 are likely to be short-lived in the lead up to Thursday’s RBNZ meeting.
The USD strengthened against most of the major currencies on Friday. Recent US data have painted a picture of a slowing economy, but not one likely to fall back into recession. US bond yields have bounced off their record lows accordingly. Friday’s better-than-expected US wholesale inventories data (1.3% vs. 0.4% expected) continued this theme.
10-year US Treasury yields rose 5bps in the wake of the data, to be roughly 30bps above late August lows. The increased yield support saw the USD post solid gains against EUR, GBP and JPY on Friday. Sentiment towards the EUR wasn’t helped by more banking sector fears. Market chatter suggested Germany’s Hypo Real Estate would require a further €40b in government aid and ECB Board member Bini Smaghi warned a debt crunch in some countries is “looming”.
After surging to an overnight high of almost 1.2740, EUR/USD skidded back towards 1.2680. In contrast, ‘commodity-linked’ currencies like AUD and NZD managed to build on their recent gains, as Friday’s encouraging Chinese trade data buoyed optimism about global growth prospects. AUD/USD finished the week near 4-month highs around 0.9270. A 3% surge in oil prices and modest gains in global equity markets also bolstered demand for ‘risk-sensitive’ currencies on Friday.
Looking ahead, developments over the weekend are likely to keep investors’ appetite for risk relatively buoyant early this week, placing downward pressure on the USD. First, Saturday’s Chinese data suggests economic growth is stabilising, after a wobbly start to the September quarter.
Retail sales, industrial production, and new loans data all came in above analysts’ expectations. The Chinese CPI jumped to 3.5%y/y (as expected), but we note this was largely due to the one-off impact of flooding on food prices. Second, uncertainty about the capital adequacy of European banks is likely to fade after the Basel Committee reached a deal to increase capital ratios to 7% this morning.
The increase was slightly less than some had feared and banks will have until the end of 2018 to implement the new rules. The tone of this week’s data will also be important in determining whether investors’ healthy risk appetite can be sustained. US retail sales and consumer confidence, along with various regional manufacturing reports, will no doubt receive the most attention.
On Wednesday, Japan’s ruling party will decide whether to keep current PM Kan in the top job or replace him with challenger Ozawa. This will have important implications for the JPY, given Ozawa is known to favour intervention to stem the rising JPY.
* Mike Jones is part of the BNZ research team.