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Currency markets take a rollercoaster ride with risk aversion in the ascendancy

Currency markets take a rollercoaster ride with risk aversion in the ascendancy

By Mike Jones

The NZD has been the strongest performing currency over the past 24 hours. In a notably whippy overnight session, the NZD/USD shook off early losses to climb to a 1½ week high around 0.7990. The strength in the NZD reflects a couple of factors. First, a recovery in global commodity prices.

After initially suffering in the wake of China’s surprise hike in reserve requirements, global commodity prices rose late in the night, bolstering sentiment towards “commodity currencies” like the NZD and AUD. The CRB index bounced 1.3% off its lows to finish up 0.2% for the night. Oil prices also ended the night firmer, but remain over 3.5% below where they started the week. Second, sharp gains in the NZD/AUD.

Yesterday’s notably soft Australian jobs figures (-22.1k vs. +17k expected) saw Australian markets trim the chances of a June RBA hike to around 15%, from 30% prior to the numbers. NZ-AU 3-year swap spreads rose from -170bps to -162bps accordingly and the NZD/AUD leapt from 0.7380 to above 0.7440. Overnight, solid NZD/AUD demand from custodial and real money accounts was responsible for a further ½ cent probe to the topside.

Looking ahead, the NZD/AUD is approaching the top end of our short-term valuation model’s 0.7250-0.7450 “fair-value range” (based on NZ-AU interest rate differentials, relative commodity prices and business confidence). So we’ll have to see an improvement in the model’s drivers for the NZD/AUD to sustain further significant gains.

We actually favour a mild NZD/AUD pull-back towards 0.7350 in coming weeks. Our view is that Australian markets are now underpricing the chances of a June/July RBA rate hike (we look for a 25bps hike at one of these meetings, compared to the cumulative 8bps of tightening priced by the market).

If we are right, NZ-AU rate differentials should fall back before long, dragging the NZD/AUD lower again. There is relatively little event risk due over the next 24 hours (although watch Eurozone GDP tonight). As such, volatility in equity and commodity markets will remain important for dictating currency market sentiment.

Majors

It has been a real roller-coaster ride in currency markets overnight. The USD has finished up marginally weaker relative to most of the major currencies.

Early in the night, risk appetite took a hit from a surprise 50bps hike in reserve requirements from the People’s Bank of China. Following a weak lead from Asian stocks, European equities slipped 0.5-0.9% and global commodity prices continued to lose ground. Comments from the IMF that Europe’s debt crisis may yet spread to ‘core’ and emerging Europe only served to further spook markets.

With risk aversion in the ascendancy, investors sought out the relative “safe-haven” of the USD and JPY. EUR/USD skidded to 6-week lows below 1.4150, USD/JPY briefly slipped below 80.80, and the GBP/USD plunged from above 1.6360 to around 1.6240. Falls in the GBP and EUR were exacerbated by more uninspiring economic data. UK industrial production rose a disappointing 0.3%m/m in March (0.8% expected), with Eurozone IP figures also underwhelming (-0.2%m/m vs. +0.3% expected).

However, investors’ mood generally improved as the night wore on. Most of this seemed to reflect an agreement between US President Obama and Senate Republicans to raise the level of the US debt ceiling. US stocks rose, commodity prices pared their losses and risk appetite improved. After spiking to almost 18%, the VIX index (a proxy for risk aversion) settled back to around 16.2%. “Safe-haven” currencies gave up most of the earlier gains as a result, with most of the major currencies finishing the night firmer against the USD.

The EUR staged one of the more aggressive rebounds of the night following some hawkish commentary from ECB officials. Coene said April’s ECB rate rise was “certainly not” a one-off and Stark said “I think it is a necessity to withdraw monetary accommodation”. From an overnight low around 1.4130, EUR/USD bounced back to 1.4270. The strength of tonight’s Q1 Eurozone GDP figures (0.6%q/q expected) will help determine whether the EUR can extend its gains.

Fixed Interest

Markets It was another rather uneventful day in NZ interest rate markets. Bond yields inched a little lower with swaps virtually unchanged. Yesterday’s DMO auction passed with less drama than has been the case recently. Bid-to-cover ratios for the auction of $100m of 17s and $200m of 19s were solid at 2-2.5x but were well off the 8x seen in recent weeks. Bond yields crept lower to around 3.21% on 13s and to around to 5.25% on 21s.

Yesterday’s April food price index rose around 0.1%m/m to be up 6.1% on a year ago. This keeps our forecast for Q2 CPI at 5.4% y/y. With inflation pressures gently coming back into focus we continue to see the RBNZ beginning to remove its extremely accommodative policy by year end. We expect the OCR be 100bp higher in a year’s time. Our OIS model suggests the market is looking for somewhat less, with around 45bp priced over the next 12 months.

The US auction of $16b 30 year bonds saw a bid-to-cover ratio around 2.5x also somewhat lower than in recent auctions. US long yields may also have got a nudge higher from PPI data that came in above expectation at 0.8%m/m (0.6% expected) to be up 6.8%y/y. Another relatively quiet day in NZ interest rate markets is expected today with no key local events.

This evening’s US CPI data will be an important indicator of how the inflationary environment is developing which will ultimately drive US yields higher. This has implications for NZ long end rates due to the solid correlation between the two.

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See our interactive swap rates charts here and bond rate charts here.

Mike Jones is part of the BNZ research team. 

All its research is available here.

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1 Comments

The mind boggles under pressure in the currency market – big changes ahead.

Zh, zh - all these predictions about the NZ$ ??? Major currencies, often countries (economic bloc) also are in trouble of difference reasons and therefore losing ground. The NZ$ in the dragrope of the AU$ could even move into a temporary “Anchor currency”.

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