Kiwi dollar flirts with US80c well ahead of 'fair value' range of US74c to US76c

By Mike Jones

For the second week running, the NZD was the strongest performing G10 currency last week. On Friday, the NZD/USD flirted with 0.8000 for the first time since June 2008. The NZD found support from both the local and global backdrops last week.

Globally, buoyant risk appetite underpinned robust demand for “growth-sensitive” currencies like the NZD, even as global commodity prices pared some of their recent gains. Our risk appetite index (long run average = 50%) rose to 2-month highs of 73.7%.

Closer to home, a jump in RBNZ cash rate expectations (see fixed interest section) saw NZ-US interest rate differentials become less of a drag on the currency. Indeed, NZ-US 3-year swap spreads soared 35bps to 260bps – the highest since the February 22nd Christchurch earthquake.

Helping to bolster confidence in the NZ economic outlook, March electronic card transactions rose a solid 1.3% and RBNZ Governor Bollard noted the positive terms of trade (and currency) implications of NZ’s commodity price boom. It’s worth noting, last week’s gains in global risk appetite and NZ interest rates have seen NZD/USD “fair-value” increase around 2 cents.

Our short-term valuation model currently suggests a “fair-value” range of 0.7400-0.7600. While this puts recent NZD/USD strength on a surer “fundamental” footing, the currency is still undoubtedly overstretched around 0.8000. Today’s Q1 CPI number looms large as a key determinant of near-term NZD fortunes. We, and the market, are picking a 1.0% quarterly gain, stronger than the RBNZ’s 0.7%. This would lift the annual rate to 4.7% (from 4.0%).

Absent a stronger-than-expected CPI number, we suspect the NZD/USD will struggle to push much farther to the topside this week. Heading into the Easter break, we may well see speculative and leveraged accounts take profit on long NZD and AUD positions, knocking the currency lower.

According to CFTC figures, net long positions in the AUD reached the highest level on record last week. In the short-term, support on NZD/USD is seen on dips to the 0.7930 region. Headwinds are expected on bounces to 0.8030, with heavier resistance expected around 0.8100.

Majors

The USD index staged a modest recovery from 16-month lows on Friday, as rising demand for “safe-haven” assets offset the impact of tame US inflation figures. The USD index ground up from below 74.70 to above 74.80. Investors’ buoyant appetite for risk was tested by a couple of factors.

First, Friday afternoon’s stronger than expected Chinese growth and inflation figures revived concerns over aggressive policy tightening. Chinese GDP growth eased only slightly to 9.7% (9.5% expected), while CPI inflation accelerated to 5.4% (5.2% expected).

In response, equity markets in Asia notched up small losses while European and US indices managed to eek out gains of 0.01-0.5%. Second, ongoing chatter about the likelihood of a Greek debt restructuring (the German deputy finance minister suggested it "would not be disaster") and Moody’s two notch downgrade of Ireland (to Baa3) piqued European sovereign debt concerns. Peripheral sovereign CDS spreads widened in response – Spanish 5-year CDS spreads increased 15bps to 234bps.

Reflecting investors’ less confident take on the global economy, “safe-haven” assets performed well on Friday. Gold prices surged to a fresh all-time high and US Treasury yields dipped 6-10bps. Investors also trimmed long positions in EUR/USD and GBP/USD, in favour of “safe-haven” currencies like CHF, JPY and the USD.

Friday’s swathe of US data was a little mixed, but evidence of weak core inflation certainly helped limit the extent of Friday’s USD gains. CPI ex-food and energy ticked up 0.1%m/m in March (compared to the 0.2% expected).

Fixed Interest

Markets Last week witnessed a meaningful sell-off in NZ bond and swap markets (higher in yield), on the back of comments by RBNZ’s Bollard suggesting that the RBNZ was less inclined to look through the inflationary impact of high commodity prices. Our OIS model shows that markets have raised their expectation to close to 50bp of RBNZ rate hikes over the next 12 months, with the first 25bp hike fully priced by year end. Previously, only 29bp of hikes were priced over 12 months.

This brings the market closer to our own expectation that the RBNZ will start to raise rates by year end, with the OCR 75bps higher in a year’s time. As a consequence, NZ 2-year swap yields rose 14bp to 3.46% and 10 year yields by 12bp to 5.49% last week. Two year yields are now back at levels seen immediately post the Christchurch earthquake. In bond markets, 04/13s yields have also risen meaningfully to 3.57%, 11bp higher on the week. 05/21s however were virtually unchanged at 5.77%, resulting in a flatter Government bond curve, and a narrowing of the negative EFP spread between 10 year swap and bonds to -25bp.

NZ long bonds were likely influenced by US Treasuries that rallied over the past week with yields falling from around 3.6% to 3.4%. Friday’s US core CPI reading for March came in below expectation at 0.1%m/m (0.2% expected) with the market reading it as providing less pressure on the Fed to begin removing its highly stimulative policy.

The market is now pricing the Fed Funds rate to be just over 30bp higher in a year’s time. Today’s Q1 NZ CPI reading will be an important driver of the market this week. A higher reading will likely result in a further sell-off in fixed interest markets.

Mike Jones is part of the BNZ research team. 

All its research is available here.