By Mike Jones
Despite some chinks appearing in the NZD’s armour, the currency finished last week marginally stronger. After slipping to around 0.7500 mid-week, a mild short squeeze saw the NZD/USD close out the week above 0.7600.
Broadly speaking, the NZD/USD continues to be torn between the positive impact of strong and rising global commodity prices, and the negative impact of near-term weakness in domestic data. Last week’s Q4 retail statistics were certainly indicative of a still struggling domestic economy.
The 1.1%q/q decline in headline sales was enough to keep the market’s expectation of no more RBNZ hikes until October intact. The associated downward pressure on NZ interest rates saw NZ-US 3-year swap spreads hover around 18-month lows, close to 250bps, for most of last week, limiting the upside in the NZD/USD.
At the same time, surging global commodity prices offered support to the NZD. The CRB index (a broad index of global commodity prices) finished the week up a further 1.2%, and global dairy prices surged another 3.9% at last week’s Fonterra auction. In thinking about the short-term NZD/USD outlook, much depends on whether the domestic negatives or global positives ultimately shine through. We’re unlikely to get any firm answers on this front this week, particularly given this week’s comparatively quiet NZ data schedule.
So, all up, the stage appears set for more rangy trading in NZD/USD this week. However, if anything, we favour the downside. Not only is fundamental support for the USD beginning to emerge (through rising US bond yields), but valuation metrics continue to suggest the NZD/USD is a touch overstretched. Our short-term valuation model currently estimates a NZD/USD “fair-value” range of 0.7300-0.7500. This suggests to us the NZD/USD will struggle to sustain rallies above 0.7750 in the short-term, with a push back towards 0.7500 looking more likely in coming sessions.
The USD weakened against most of the major currencies on Friday night. For the most part, the GBP and EUR led the gains against the USD as rising cash rate expectations continued to underpin the European currencies.
Not only were Friday’s UK January retail sales figures fairly encouraging (1.9%m/m vs. 0.5% expected), but rumours Bank of England Deputy Governor Bean may have voted for a rate hike in February also did the rounds. In response, the extent of BoE tightening priced into the UK OIS curve jumped from 75bps to around 85bps, underpinning the GBP/USD’s climb from 1.6150 to above 1.6250. It was a similar story for the EUR.
The EUR/USD surged from 1.3550 to almost 1.3700 after European interest rate markets moved to factor in nearly 87bps of tightening from the ECB over the next 12 months (from 80bps the night before). This followed some fairly hawkish comments from ECB policy maker Smaghi. He said "…the degree of accommodation of monetary policy has to be monitored and, if needed, corrected."
There was almost no lasting reaction to China’s decision to hike banks’ reserve requirements a further 50bps. Still, “growth-sensitive” currencies like the AUD, CAD and NZD generally underperformed on Friday reflecting a flat-lining in commodity prices. The CAD took out the title of weakest performing currency following the release of January’s relatively mild Canadian inflation figures (2.3%y/y vs. 2.4% expected).
The weekend’s G20 meeting was something of a damp squib. G20 finance ministers hashed out an agreement on how to measure global imbalances, but didn’t go so far as to set numerical targets for such. Indicators such as public debt, fiscal deficits, private savings, and the trade balance will all be used. However, China prevented the addition of currency reserves and exchange rates to the list.
Looking ahead, the global data calendar looks fairly light this week. European PMIs and the German IFO (tonight), US existing home sales (Wednesday) and UK Q4 GDP (Friday) look set to be the highlights.
However, there is an abundance of central bank speak to keep an eye on. Officials from the Federal Reserve, ECB, BoE, and RBA are all scheduled to speak. Should ECB and BoE policymakers pour cold water on the market’s relatively hawkish monetary policy expectations, we’d expect the GBP and EUR to lose some of their lustre, providing support to the USD.
A further escalation in the current political tensions in the Middle East would also support the USD through increased “safe-haven” demand. Near-term, solid support on the USD index is eyed towards 77.00.
Mike Jones is part of the BNZ research team.