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Greenback firms up on potential early end to quantitative easing

Greenback firms up on potential early end to quantitative easing

By Mike Jones

The NZD has been the strongest performing G10 currency over the past 24 hours. The NZD/USD thumbed its nose at a broad strengthening in the USD, climbing from 0.7500 to around 0.7570 – the highest since the February 22nd Christchurch earthquake. Currencies put in a bit of a mixed performance overnight.

The EUR, JPY and GBP were knocked back by a firming in the USD, as St Louis Fed President Bullard warned the FOMC could end its quantitative easing programme early if the US economy continues to improve. In contrast, “growth-linked” currencies like the AUD, NZD and CAD found support from further recovery in investors’ risk appetite. The lack of any fresh bad news from the Middle East or Japan saw US stock markets post modest gains and our risk appetite index (which has a scale of 0-100%) grind up from 64.9% to 66.5%.

Along with generally improved appetite for “risky” assets like the NZD and AUD, solid demand for NZD/EUR and NZD/JPY from momentum and speculative accounts also underpinned the currency overnight. NZD/JPY leapt from 61.40 to above 62.20 and NZD/EUR climbed ½ cent to 0.5370. In the near-term, we suspect NZD/EUR gains will be limited to around 0.5500 as European economic growth continues to outpace that of NZ.

However, we expect NZ-EU growth and interest rate differentials will move in support of the NZD/EUR late in 2011, which should see the currency trend higher again. For today, the backdrop of a generally firmer USD is expected to keep the NZD/USD in check. Initial resistance is reasonably close at 0.7580, with heavier selling interest expected around 0.7640. Keep an eye out for February building consents data at 10:45am. We are expecting consents to be broadly flat on a month earlier, which will leave them down almost 20.0% on the same time last year.

Majors

The USD strengthened against most of the major currencies overnight, as hawkish Fed rhetoric spurred further gains in US bond yields. The USD actually started the night on the back foot thanks to strength in the EUR. Not only did March German CPI figures overshoot analysts’ expectations slightly (0.5%m/m vs. 0.4% expected), but ECB Governing Council member Makuch said an ECB rate rise next month is “highly likely”. In response, traders priced in slightly more ECB tightening over the next 12 months (127bps of tightening now priced), bolstering EUR sentiment.

EUR/JPY surged from 115 to above 116 and EUR/USD leapt from 1.4080 to above 1.4140. In line with the strength in the EUR/USD, the GBP/USD and AUD/USD were dragged up to 1.6040 and around 1.0270 respectively. Last night’s UK data had little impact on the GBP. The third release of fourth quarter UK GDP revealed a small upward revision (-0.5%q/q vs. -0.6% expected), but generally weak money growth figures tended to offset the good news (M4 growth excluding intermediate other financial corporations showed growth slowing to just 0.5%).

Later in the night, relatively hawkish comments from St Louis President Bullard provided some fundamental support for the USD. The JPY, EUR and GBP bore most of the brunt of the late USD strength. Bullard’s speech focused on the exit strategy for the Fed’s super easy monetary policy, suggesting the US$600b QE2 programme could be trimmed back by $100b in response to improvements in the US economy. With markets already on alert for hints of a change in tone from the Fed, the comments saw 2-year US Treasury yields jump from 0.77% to 0.82%. 10-year yields finished the night up 4-5bps at around 3.49%.

As a result, USD/JPY climbed from below 81.80 to above 82.40, EUR/USD eased back to where is started the night around 1.4080 and GBP/USD dribbled back to around 1.5990. Along with the stronger USD, ratings agency S&P’s downgrade of Greece and Portugal also likely contributed to the softer EUR. The Portugese/German 10-year bond spread rose to another record high of 466bps.

Looking ahead, tonight’s US ADP employment survey will help analysts firm up expectations for Friday’s all important non-farm payrolls release. Analysts currently expect a payrolls gain of 190k, so we’ll have to see a result north of this for the USD to continue to climb. Solid support on the USD index is eyed on dips towards 75.90.

Mike Jones is part of the BNZ research team. 

All its research is available here.

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