By Mike Jones
The NZD was the weakest performing currency last week.
More evidence of lacklustre NZ economic momentum, combined with a less upbeat global backdrop, saw the NZD/USD slip from 0.7700 to around 0.7550.
Last week’s data showed the NZ economy is still far from a picture of a health. REINZ data for December revealed a housing market still firmly in the doldrums, Q4’s GST-driven 2.3% increase in the CPI won’t have troubled the RBNZ, and November retail sales looked decidedly weak, at heart.
Not surprisingly, the downbeat data saw investors further scale back the extent of RBNZ tightening expected this year, weighing on the NZD.
From around 300bps at the start of the week, NZ-US 3-year swap spreads ended the week 10bps lower around 290bps. A bout of NZD/EUR selling also provided headwinds for the NZD last week. Not only did investors become more optimistic that fresh steps will be unveiled to end the European debt crisis, but mounting inflation fears bolstered ECB rate hike expectations. Indeed, a total of 75bps worth of ECB tightening is now expected over the next 12 months (compared to 65bps from the RBNZ).
Looking ahead, the upcoming NZ data week is relatively quiet, with Thursday’s OCR Review also primed to be devoid of drama. We expect the Reserve Bank’s one-pager to essentially reiterate the reserved tones of the December MPS, while leaving the OCR rate-cycle language open-ended enough to validate current market pricing. In contrast, the US data calendar is chock-a-block.
Tomorrow morning’s FOMC meeting, and a slew of US data later in the week should provide plenty of direction for the USD.
As a result, we expect the NZD/USD will take its cues from USD sentiment this week. It’s worth noting, NZD/USD “fair-value”, as estimated by our short-term valuation model, edged lower last week. The model now suggests a “fair-value” range of 0.7450-0.7650. We suspect the NZD/USD will spend most of the rest of the week contained by this range. Stiff headwinds are expected on rallies towards 0.7750.
Since our last report on Friday, the USD has continued to decline. In fact, on a trade-weighted basis, the USD has fallen around 1.3%. Global equity markets managed to eke out further modest gains overnight, as the Q4 US corporate earnings season continues to impress. The S&P500 is currently up around 0.5%, following gains of 0.01-0.8% on European bourses. The mild improvement in risk appetite saw investors trim positions in “safe-haven” currencies like the USD and JPY.
Against the broadly weaker USD, the EUR was one of the night’s strongest performers. Not only did the Eurozone PMI’s continue the recent run of better-than-expected European data, but US think tank Medley suggested the ECB could raise interest rates as early as Q3. From below 1.3600, EUR/USD climbed to 2-month highs above 1.3650. A broadly weaker USD was also the dominant theme of Friday’s offshore session.
Gains in the EUR were once again instrumental in setting the scene for a weaker USD. Risk-appetite was supported by upbeat economic news in Germany and a better-than expected earnings report from General Electric. The S&P500 closed up 0.2% on Friday, while commodity prices as measured by the broad CRB index were 0.6% higher. Stock markets advanced in Europe and sovereign credit spreads generally fell, thanks to increasing confidence that policymakers would prevent an escalation of the debt crisis.
ECB board member Stark said the ECB could buy government bonds or inject cash into commercial banks as part of a scheme to strengthen the Eurozone bailout fund.
Also helping EUR was continuing good economic news, helping cement the market’s expectation the ECB will hike rates 75bps over the next 12-months. The IFO measure of German business sentiment increased to its strongest in 20-years, while French business confidence also rose strongly.
Looking ahead, we wouldn’t be surprised to see the USD remain heavy this week. Wednesday morning’s FOMC meeting is widely expected to bring no change to the Fed’s quantitative easing programme.
Recent US data releases suggest the recovery is gaining some traction, but the level of unemployment remains high and core inflation is still extremely subdued. Elsewhere, generally solid analyst expectations for this week’s plethora of US data suggests a high hurdle for the positive surprises needed to trigger further USD gains.
Reports on home sales, durable goods orders, consumer confidence, and GDP will all be worth watching. All up, we suspect rallies will be limited to 79.00 on the USD index.
Mike Jones is part of the BNZ research team.