Concerns mount over the sovereign solvency of Ireland as G-20 meeting in Seoul kicks off

By Mike Jones

The NZD/USD has spent the past 24 hours trading choppily inside a 0.7780-0.7880 range.

The NZD started the night on the front foot. Not only did yesterday’s swathe of Chinese data reaffirm Asian growth momentum, but a mildly disappointing Australian employment report spurred a sharp rally in NZD/AUD. Sure the 29.7k jobs added in October exceeded analysts’ expectations (of 20k).

But with all of this employment growth coming in part time jobs, and the unemployment rate rising to 5.4% from 5.0%, expectations of a December RBA rate rise tended to recede in the wake of the release.

The NZD/AUD was propelled from 0.7780 to around 0.7830 as a result. According to our short-term NZD/AUD valuation model, NZD/AUD looks “overvalued” around these levels. Based on NZ-AU 3-year swap spreads, NZ-AU commodity prices and relative business confidence, the model currently estimates a 0.7400-0.7600 “fair-value” range. In the absence of further uplift in NZ-AU interest rate spreads, we would expect NZD/AUD to head back towards this range in coming weeks.

Overnight, positive sentiment towards the NZD evaporated. The start of the G20 summit was largely ignored by markets as mounting concerns over the sovereign solvency of Ireland gripped markets. Indeed, Irish borrowing costs hit record highs as investors fretted over Ireland’s ability to impose crippling fiscal austerity measures. The associated souring in global growth sentiment saw global equity markets post modest declines, commodity prices fall and risk appetite dry up.

Rising risk aversion bolstered demand for the “safe-haven” of the USD at the expense of the EUR, AUD and NZD. Before long, NZD/USD had skidded from 0.7860 to around 0.7780. For today, the local data calendar is bare so expect the NZD to take direction from Asian equity markets.

Overall, we suspect the current backdrop of reduced risk appetite and equity market weakness will limit NZD/USD rallies to around 0.7870. Solid support is expected towards 0.7730.

Majors

A modest strengthening in the USD was the major theme in currency markets overnight. Over the week, the USD index has appreciated around 2%, reflecting renewed “safe-haven” demand and rising US bond yields.

With US (bond) markets shut for Veteran’s Day, it wasn’t surprising to see investors’ focus remain in Europe overnight. European sovereign credit spreads continued to push higher as investors fretted over a possible Irish sovereign default. Risk appetite, global equity markets, and the EUR were all pressured lower as a result.

There wasn’t any fresh news of note regarding the Irish crisis. However, comments from European Commission officials that the EU stands ready to support Ireland should it require assistance didn’t do much for confidence. The spread between Irish and German 10-year bonds blew out to a record high of 650bps.

By comparison, the spread to Greek bonds is currently around 920bps. European equity indices slipped 0.1-0.8%, while US stocks fell slightly more following a noticeably gloomy profit outlook from Cisco (stocks in which plummeted 17%). The VIX index (a proxy for risk aversion) jumped from 18.5% to above 19.5%. Reflecting the downbeat sentiment, investors sought out the relative “safe-haven” of currencies like the USD and JPY.

A report from a US think-tank suggesting the Fed may yet scale back the size of its quantitative easing program further bolstered USD sentiment. Given mounting fears over Europe’s debt crisis, it wasn’t surprising to see the EUR bear most of the brunt of the stronger USD; EUR/USD tumbled from 1.3800 to 1-month lows around 1.3650.

In contrast, GBP bucked the stronger USD trend as expectations of additional UK monetary easing continued to recede following yesterday’s surprisingly hawkish Bank of England quarterly inflation report.

GBP/USD spent the night shuffling sideways, while EUR/GBP slipped to a near 2-month low below 0.8480. With all eyes on Ireland, there was less attention on the G20 summit that kicked off overnight. There was nothing earth shattering for markets in any case. As expected, China and the US traded jibes on exchange rate policies, while the remaining members discussed ways to ease global imbalances and exchange rate tensions.

The draft communiqué suggests leaders will back "indicative guidelines" on correcting current account imbalances, but the idea of strict limits put forward by the US was ruled out. Tonight, markets will be on alert for the final release of the G20 communiqué, with the advance estimate of Q3 Eurozone GDP growth also likely to attract considerable attention.

* Mike Jones is part of the BNZ research team. 

All its research is available here.