NZ$ hit as Euro equity makets fall over 5% and investors run for safety

By Mike Burrowes and Kymberly Martin

NZD

NZD/USD was the worst performing currency over the past 24 hours, shedding over 1 ¼ cents to 0.8320 currently. The sharp fall in NZD/USD was exacerbated by decent stop-loss selling from short-term accounts as they exited last week’s long positions en-masse.

The NZD took its cues from a sharp fall in European equity markets as concerns resurfaced around the government deficits of Italy and Greece. In equity markets, the Euro Stoxx 50 index and German DAX index shed a whopping 5.1% and 5.3% respectively. Commodity prices also suffered overnight, with the CRB index (broad of global commodities) down 0.8%.

The NZD has given back some of its recent gains against the EUR and GBP. Despite the renewed concerns on Europe, NZD/EUR dropped to 0.5900 from 0.5960 at the beginning of the evening. NZD/GBP fell from 0.5210 to 0.5160 currently.

NZD/AUD moved sharply lower overnight, falling from 0.7960 to 0.7880 currently. There is no shortage of event risk for the cross today. The highlight will be the RBA interest rate decision. The market is pricing over a 20% chance of a 25bp cut. Given we expect no change from the RBA, we caution about the potential for a pull back in the cross to 0.7850. However, any dips below this level are likely to be short lived given we expect NZ-AU interest rate and growth differential to move in the NZD’s favour over the medium-term.  

With no local data out today, expect the NZD to take its cues from across the Tasman. In this regard, we have the release of the Q2 current account, home loans and the RBA interest rate decision (4.30pm NZT). Initial support is seen for NZD/USD at 0.8270 and resistance at 0.8360.

Majors

Risk sentiment was smacked overnight as markets turned their attention back to the mess in Europe. The renewed concerns over Greece and Italy saw European equity markets collapse and ‘peripheral’ European interest rate rise. The USD index responded in its “safe haven” role, rising 0.7% to 75.20.

The EUR faltered overnight as the market fretted over the state of Italian public finances. The renewed concerns have seen interest rates and CDS spreads for Italian government debt rise sharply (see below). EUR/USD plunged from 1.4160 to an overnight low around 1.4060, currently 1.4090. Adding to the negative tone was concerns Greece will fail to meet its budget deficit targets. Greece must meet the IMF’s targets in order to receive the next aid tranche.

The next key test for the EUR will come on Thursday when the ECB deliver their interest rate decision. While no change in rates is expected, speculation is mounting that ECB President Trichet will be more dovish in the accompanying press conference. Indeed, the OIS market is currently pricing 32bps of rate cuts from the ECB over the next 12 months, from 26bps of cuts yesterday.  

Growth prospects in the UK are not looking much better. Overnight, weaker-than-expected UK PMI services data for August (51.1 vs. 54.0 expected) helped spur speculation the Bank of England may start another round of asset purchases to bolster growth. Over the course of the evening, GBP/USD fell to a low of 1.6060, its lowest level since 21 July. For now, the BoE is widely expected to leave rates and its asset purchase programme unchanged.

The risk sensitive NZD and AUD suffered heavy losses overnight. AUD/USD opened the week around 1.0620, but shed over a cent to 1.0510 in the early hours of this morning. AUD/USD is currently trading around 1.0550. Near-term direction on AUD/USD will likely come from the RBA interest rate decision today. We expect the RBA to leave rate unchanged, suggesting some short-term upside to AUD/USD.  

Looking to the night ahead, we have Eurozone Q2 GDP, German factory orders and US ISM non-manufacturing data. Expect a speech by the Fed’s Kocherlakota to garner attention as the markets tries to get a better read on the Fed’s appetite for another round of quantitative easing.

Fixed Interest Markets

NZ swap and bond yields fell yesterday, following the lead of their off-shore counterparts on Friday. As long-end yields have fallen more heavily than short-end yields, curves have flattened further.

2-year swap yields fell 6bps to 3.31% yesterday. They look to be approaching the bottom of their range, with paying interest apparent around 3.30%. 10-year yields fell 13bps to 4.68%. The 2s-10s spread has broken below 140bps for the first time since November last year. Assuming the global backdrop remains uncertain, we expect the curve to flatten further. Major support is not seen until 120bps.

Bond yields also declined, with the yield on 21s falling from 4.54% to 4.45%, just above the late August lows. Australian 10-year bond yields have fallen sharply from 4.41% to 4.24%. Australian 10-year bond yields are now trading 21bps below NZ yields, retouching lows for the year. This now suggests relative downward pressure on NZ long yields. This is despite the lack of demand shown at last week’s NZ DMO bond auction.

Risk aversion picked up again overnight after the defeat of German Chancellor Merkel’s party in her home state. This has heightened concerns about German participation in a long-term resolution of the Eurozone crisis. Concerns regarding Italian Prime Minister Berlusconi’s implementation of austerity plans also continue to build.

The renewed concerns in Europe saw “safe haven” demand for German bonds.10-year yields made new all time lows, trading from 2.0% down to 1.85%. Italian and Spanish bond yields have spiked higher to 5.56% and 5.26% respectively, toward levels where the ECB previously stepped in to buy sovereign bonds. CDS spreads (a measure of default risk) for Greece and Italy have made new highs. As it was a US holiday, US bonds were not trading.

With the deterioration in risk appetite seen overnight, expect further downward pressure on NZ yields today. There are no NZ data releases but today’s RBA announcement will be important. We expect the RBA to remain on hold and show little inclination for cutting rates, despite the fact the market still prices over a 20% chance of a 25bps cut.

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

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

All its research is available here.