NZ dollar solid just under 80 USc, but may struggle in week ahead on Euro debt fears, US growth wobbles and any China slowdown

NZD support from the global backdrop cooled last week. Economic data out of the US and Japan wasn’t particularly inspiring. Meanwhile, chatter about a possible Greek sovereign debt restructuring undermined confidence in the Eurozone. As a result, investors dialled back their appetite for risk somewhat (our risk appetite index eased from 70% to 67%), tempering demand for “growth-sensitive” currencies like the NZD/USD.

 

It was a different story on the domestic front. ANZ-RM consumer confidence rebounded, March quarter producer prices proved more inflationary than the market anticipated, Fonterra milk prices consolidated at elevated levels, and the NZ Budget forecast a return to surplus a year earlier than previously flagged. Further evidence of underlying economic resilience helped limit any NZD losses. And with worries about a Greek default taking a toll on EUR sentiment, NZD/EUR was propelled to 3-month highs above 0.5600.

 

Following the hoopla of the Budget, NZ gets a big breather this week with Tuesday’s RBNZ inflation expectations survey the only macro-economic report of note. We’re expecting the 2-year ahead measure to hold around the 2.6% mark.

 

Sentiment towards the global economy will remain key to the fortunes of the NZD/USD in coming weeks. There are still plenty of risks on this front for investors to fret over. US growth momentum is showing signs of flagging, concerns about a possible Greek debt restructuring look set to linger, and there is every chance worries about Chinese policy tightening could flare up again. Against this generally uncertain backdrop, we doubt commodity prices and risk appetite are about to re-test their late April peaks. If we are right, “growth-sensitive” currencies like the NZD/USD look set to struggle.

 

In the short-term, the NZD/USD looks fairly well entrenched in the familiar 0.7750-0.8000 range. We suspect more choppy trading inside this range is likely this week.

 

Majors

The USD strengthened against most of the major currencies on Friday. A sharp sell-off in the EUR was mostly responsible for driving the USD higher, as a stream of negative news hit the single currency.

 

First, Norway suspended the payment of a €42m grant to Greece for failing to comply with EU-IMF bailout conditions. Second, Fitch slashed Greece’s sovereign credit rating a further three notches to B+, and third, Citigroup grabbed a few headlines by putting out a short EUR/USD recommendation. European peripheral sovereign credit spreads widened by 20-70bps. 

 

From above 1.4330, EUR/USD skidded back to around 1.4150. At the same time, EUR/GBP slipped from 0.8830 to closer to 0.8700 amid heavy selling from custodial and macro players. Buoyed by the weaker EUR/GBP, the GBP/USD shuffled sideways in a 1.6160-1.6300 range.

 

It wasn’t long before market sentiment more broadly began to suffer from the renewed European sovereign debt jitters. Global equity markets notched up declines of 0.1-1.2% and the VIX index (a proxy for risk aversion) rose from below 16 to nearly 17.5. Gold prices jumped 1.3% to US$1510/ounce and US Treasury yields fell 2 to 5 bps, both indicative of rising “safe-haven” demand.

Looking ahead, there are a few important economic data releases to keep an eye on this week. US Q1 GDP figures on Thursday, the second estimate of Q1 UK GDP on Wednesday and May European PMI updates all spring to mind.

 

However, it may be that official rhetoric is just as important for dictating currency market sentiment, with an army of Fed and ECB speakers set to jostle for the mic this week. Unless European policy managers can convince investors Greece can avoid a debt restructuring we’d expect downward pressure to remain on the EUR/USD. Near-term support for the single-currency is eyed towards 1.4045.

 

Fixed Interest Markets

It was a quiet day in interest rate markets on Friday, after last week’s Budget. Overall last week, yields fell a few basis points along the swap curve. Yields at the long end of the bond curve fell closer to 10bp.

 

The first Government bond tender, post the Budget saw modest demand at just over $1bn for $500m on offer. $200m of 13s saw a solid 2.5x bid-to-cover ratio, while the ratio for $150m of 19s was 2.3x. However $150m of 21s saw thin bidding at just 1.25x, indicative of the recent strong rally in these bonds that has seen yields decline to just 5.15%. (They were at 5.8% as recently as mid-April).

Swap yields rose 2-4bp along the curve on Friday, retracing a little of the fall in yield earlier in the week. 10-year swaps ended the week around 5.20% and 2-years at 3.31%. 10-year bond-swap spreads are holding in positive territory at around 5bp after the strong recent bond rally.

 

US 10-year yields appear to remain quite well supported around 3.15%, after a volatile night on Friday. Yields briefly touched close to 3.19%, but failed to move higher in the backdrop of a tick up in risk appetite and weak equity markets.

 

Rating agency S&P revised down Italy’s sovereign rating outlook to ‘negative’ from ‘stable’, citing a weakened growth outlook that reduced the chances it of addressing its public debt issues. It maintained its ‘A+’ long-term and short-term ‘A-1+’ credit rating for the sovereign, the lowest rating held by the three key agencies.   On Friday, Fitch also downgraded Greece to B+ from BB+ maintaining its ‘negative watch’, though its rating remains above that assigned by S&P.