NZ$ and long dated NZ interest rate markets react positively to Budget. S&P maintains NZ on 'negative watch'

By Mike Jones and Kymberly Martin

The NZD initially spiked higher yesterday afternoon after the release of the Government’s Budget. The NZD/USD drifted off overnight however to around 0.7900.

The Government delivered a tight Budget as expected which served to somewhat placate rating agencies. While rating agency S&P maintained their current NZ sovereign rating they did however keep NZ on ‘negative watch’, stating that a downgrade is still possible if NZ’s external position does not improve.

As part of the Budget the DMO announced a reduction in bond issuance through to 2014/15 (details in fixed interest section below) when the economy is forecast to return to a modest surplus. The NZD initially gapped higher to almost 0.7940 before drifting off later in the evening.

The global backdrop overnight was one of a choppy and slightly weaker USD and a consolidation in risk appetite. Our risk appetite indicator (scale 0-100%) has ticked up a little further to 70% and equity markets made modest gains even as commodities fell (the CRB global index fell 1%).

The night saw a generally weaker NZD relative to crosses. The NZD/AUD slid to 0.7410 overnight. As European currencies strengthened overnight the NZD fell relative to both the EUR and GBP. The NZD/EUR finished the night around 0.5520.

With the Budget now out of the way, today’s NZ data focuses will be international travel and migration data and credit card billings.

Majors

The USD traded very choppily overnight ending slightly lower after an array of weak data, in the backdrop of consolidating risk appetite.

The USD index was whipped around by mixed to weak data and sometimes conflicting ‘Fed speak’. US existing home sales for April came in at -0.8%m/m (2% expected) while the May Philadelphia Fed indicator came in at 3.9 (20 expected). The US Leading Indicator moved into negative territory at -0.3%, the lowest level since March 2009.

‘Fed speak’ was varied. Comments by member Dudley suggested that although headline inflation was ‘troublesome’, raising rates would have ‘bad consequences’ for the economy. By contrast Fisher commented that the US economy had gone from having too little liquidity to too much. The USD index bounced between 75.20 and 75.50, ending the night at the lower end of the range.

The EUR moved higher in the early hours of this morning from around 1.4240 to 1.4320. The GBP got dragged along on the EUR’s coat-tails, also underpinned by UK data that was not as bad as some has been recently. The CBI industrial trends survey showed the manufacturing sector will continue to provide some offset to a stagnant outlook for the consumer sector. Retail sales-ex-fuel soared in April to 2.7%y/y. However it was likely distorted by timing of the Easter holiday and Royal wedding bank holiday. Underlying momentum still appears weak as household spending power remains sapped by sluggish earnings growth, high inflation and tax rises. The GBP crept higher from 1.6160 to almost 1.6220.

Today there are few key data releases though equity market performance will provide indications of whether tentative signs of improving risk appetite are sustainable.

Fixed Interest Markets

NZ interest rate markets rallied after the Budget was announced. NZ 10-year bond yields fell from 5.18% to 5.10%. Swap yields remained anchored at the short end but declined by 2-3bp at the long end of the curve.

As part of a generally tight Budget, the Govt announced a reduction in gross bond issuance from the $20bn announced for the current year. Gross bond issuance is indicated to be $13.5bn, 12bn 10bn and 8bn in years 2011/12 to 2014/15 respectively. This would result in net bond issuance being $5.9bn, $2bn, $10b and $-2bn in each fiscal year.

The DMO announced that later this year it will also issue a 2015 inflation-linked bond. In addition to promote liquidity in longer bond maturities the target tranche size of nominal bonds maturing on or after Dec 2017 has been increased to $12bn from $10bn.

Separately the Government announced it was issuing an ‘earthquake kiwi bond’. This is a 4-year bond that offers 4% interest on funds to be used specifically for earthquake recovery.

Although somewhat expected, the news of reduced bond issuance going forward saw demand for long bonds drag yields down by around 7-8bp. With the yields on 21s at 5.10% and 13s at 3.14% the curve flattened a bit. 10-year bond yields are now at levels seen in October last year, not long after they bottomed at close to 5%. The strong rally in long-end bonds relative to swaps has seen swap spreads (EFP) move more convincingly into positive territory at more than 5bp.

The rating agency S&P responded to the Budget by confirming our current sovereign rating whilst maintaining their ‘negative watch’. They argue a downgrade is still possible if NZ’s external position does not improve.

Elsewhere US 10-year yields reached highs around 3.24% as global risk appetite improved, but finished the night back around 3.18%.

Discussions continued regarding Greek debt restructuring with Eurozone officials adamant they will avoid any form of ‘credit event’ that would trigger paying out of credit default swaps (CDS). Pressure remains on Greece to undertake further austerity measures and privatisation.

Today’s NZ DMO tender announcement will be of interest given the recent decline seen in long bond yields.

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

Mike Jones and Kymberly Martin are part of the BNZ research team. 

All its research is available here.