Kiwi$ dragged below 76 USc by weakening Aussie$ as Queensland floods hit RBA rate hike expectations

By Mike Jones

The NZD/USD has drifted lower over the past 24 hours, weighed down by a sharply weaker AUD. This was despite a mildly positive batch of local data.

Overall, yesterday’s December Quarterly Survey of Business Opinion provided further confirmation that 2011 is shaping up as a better year than 2010.  Experienced trading conditions for the December quarter rose to -1, from -15 in September. NZIER believes this is consistent with growth of around 0.6% for the quarter. By itself, this suggests some upside to our own 0.3% pick but, importantly, leaves us feeling more comfortable that the Q3 negative reading will not be repeated.

An improving NZ growth performance is certainly part of our view the NZD/USD will continue drifting higher through to mid 2011. But, at least for now, the AUD/USD is providing most of the direction for the NZD/USD.

Reports yesterday that Queensland’s flooding woes appear to be worsening saw Australian markets further pare back the extent of RBA tightening expected this year, weighing on the AUD. Just 17bps of RBA tightening is now priced in over the next 12 months, down from 42bps at the beginning of the year.

From above 0.9950, the AUD/USD skidded below 0.9850, dragging the NZD/USD below 0.7600 from closer to 0.7650 this time yesterday. At the same time, NZD/AUD was propelled above 0.7700 as NZ-AU 3-year swap spreads increased from -130bps to around -120bps.

Looking ahead, the NZ data calendar looks fairly light over the remainder of the week so expect NZD/USD direction to come from the AUD and changes in offshore risk appetite. Global markets are firmly focused on signs of deterioration in European sovereign debt markets. Poor results from this week’s slew of European sovereign bond auctions could knock back risk appetite and the EUR further. Such a scenario may well see NZD/USD test support towards 0.7480. Initial resistance is eyed on rallies towards 0.7640.

Majors

It’s been a mixed night in currency markets. With a few exceptions, most of the major currencies spent the night chopping around inside their recent ranges. As a result, the USD largely shuffled sideways.

Yesterday afternoon, the EUR received a boost from Japan’s announcement it will buy 20% of the first issue of bonds by the European Stability Fund. EUR/JPY leapt from 107.20 to nearly 108.00 and EUR/USD broke above 1.2980. However, the EUR soon gave up part of these gains after Finance Minister Noda clarified existing EUR reserves will be used to fund the purchases.

Looking ahead, near-term EUR direction will depend on the relative success of this week’s series of sovereign bond auctions. Tonight, Portugal will auction €1.25b worth of 3- and 10-year bonds. Investors will be closely watching the resulting yields for an indication of whether an EU/IMF bailout is necessary for Portugal. Overnight, Portuguese Prime Minister Socrates said “Portugal will not ask for any aid or financial assistance for the simple reason that it is not necessary."

Elsewhere, hawkish rhetoric from Philadelphia Fed President Plosser provided some fleeting support for the USD. Plosser said the Fed’s quantitative easing programme “may soon backfire unless a gradual reversal begins”. In response, US Treasury yields rose 2-6bps, helping underpin the USD.

However, a reduction in “safe-haven” demand provided an offsetting downward influence on the USD. US equities posted modest gains after a strong start to the US earnings season, following on from a buoyant European session. The EuroStoxx50 rose 1.3% and the S&P500 is currently up around 0.5%. Indicative of improving risk appetite, the VIX index (a proxy for risk aversion) slipped from 17.5% to around 16.8%.

The generally upbeat sentiment was also reflected in commodity prices. Oil prices jumped over 2% to above US$91/barrel while the broader CRB index rose 1.5%. Still, the cheer wasn’t reflected in ‘commodity currencies’ like CAD, AUD and NZD thanks to the ongoing drag effect of the Queensland floods on the AUD.

Reports the flooding is spreading into inner city Brisbane yesterday saw Australian markets further pare back the extent of RBA tightening expected this year. Just 17bps of RBA rate hikes are now priced in, down from 42bps at the beginning of the year. The AUD/USD skidded from 0.9960 to below 0.9900 overnight accordingly.

Mike Jones is part of the BNZ research team. 

All its research is available here.