By Mike Jones
The NZD was the weakest performing currency last week. Tumbling NZ-US interest rate differentials and a sharp sell off in NZD/AUD dragged the NZD/USD from above 0.7650 to around 0.7480.
Globally, the most eye-catching development in markets last week was a surge in US bond yields. Not only did the nascent improvement in US economic data continue, but an extension to US tax breaks sent analysts scrambling to revise up 2011 US growth and inflation forecasts. Renewed optimism about the US outlook saw 10-year Treasury yields jump 32bps over the week, while 2-year yields rose almost 20bps to 0.63%.
NZ-US interest rate differentials fell away sharply as a consequence, weighing on the NZD/USD. In fact, NZ-US 3-year swap spreads tumbled over 20bps over the week to a 3½ month low around 290bps. But it wasn’t all about offshore developments.
Last week’s more dovish-than-expected RBNZ MPS certainly did the currency no favours. It appears the Bank has been spooked by the continued run of weak real economy data. The concern that this has engendered has resulted in the Bank further postponing any thoughts of resuming the hiking cycle that began in June 2010 and stalled just one month later.
Indeed, the RBNZ seems to have settled on June 2011 for the next move. With NZ interest rates back-peddling in the wake of the Statement, NZ-AU 3-year swap spreads fell to a 3-week low around -130bps and the NZD/AUD was slammed to within a whisker of 10-year lows around 0.7570. As for this week’s NZ data offerings, Thursday’s NBNZ business survey is the obvious centrepiece, as a prelude to the all-important mid-January QSBO.
The week begins with Monday’s Food Price Index, for November, for which we expect a -0.3% correction. Absent a major local surprise (watch out for Tuesday’s retail and REINZ housing data), direction for the NZD is expected to come from offshore this week. Keep an eye in particular on Wednesday morning’s FOMC meeting which is shaping up as a key determinant of USD sentiment in coming weeks.
It’s worth noting, last week’s fall in relative interest rate differentials has shaved around 1½ cents of the “fair-value” range implied by our short-term NZD/USD valuation model.
The model now estimates a fair-value range of 0.7350-0.7550, suggesting little fundamental reason for the currency to sustain rallies above 0.7600 in the short-term.
Currency markets struggled for direction somewhat on Friday night. As a result, the USD spent most of the night shuffling sideways and most of the major currencies were confined to familiar ranges. As with most of last week, surging US bond yields occupied most of traders’ attention on Friday. Indeed, 10-year US Treasury yields jumped a further 11bps, to end the week a whopping 32bps higher around 3.31%. Fundamental support for the USD was bolstered as a result – the USD index finished last week up 0.9%.
Early in the week, sentiment towards the US economy brightened noticeably following US President Obama’s tax package. Friday’s US data simply continued this theme. The University of Michigan consumer confidence index soared to the highest level in 6 months (74.2 vs. 72.5 expected) and the October trade balance contracted by much more than expected (-US$38.7b vs. -US$43.8).
Equity markets generally saw out the week in reasonably fine fettle, the S&P 500 closing up 0.6% after a mixed performance from European indices. As widely expected, the People’s Bank of China raised banks’ reserve requirements 50bps to 18.5%, a record high for most of China’s banks. This followed more evidence of rising Chinese inflation pressures. The weekend’s November CPI matched earlier rumours of a 5.1% gain and industrial production (13%y/y), retail sales (18.4%) and investment figures (24.3%) all came out strong, broadly as expected.
Looking ahead, a further reduction in trading volumes and liquidity is expected this week as markets approach year-end.
Along with a busy events calendar, this has the potential to promote increased volatility in currency markets. Early in the week, markets will be watching developments in the US Senate to see whether Obama’s tax package is passed. Traders will also be keeping a watchful eye on an EU leaders meeting beginning on Thursday. Investors are hopeful (but not holding their breath for) some kind of unified response to the crisis that continues to plague European sovereign debt markets.
Wednesday morning’s FOMC meeting will probably be the highlight of the week. The USD index has lifted nearly 4% since the Fed restarted quantitative easing (QE) on 4 November. So the Fed’s comments around QE and the recent improvement in US economic data will be critical to whether the USD can continue to rally. Should the Fed downplay the need for further QE and/or upgrade its economic outlook, we wouldn’t be surprised to see the USD index test resistance towards 80.5. Near-term support is eyed around 79.70.
* Mike Jones is part of the BNZ research team.