'Only a global recession will prevent the domestic recovery and need for the RBNZ to lift rates'

By Mike Burrrowes and Kymberly Martin

NZD

The NZD has stabilised over the past 24 hours.

NZD/USD traded down to 0.8160 yesterday morning but has subsequently recovered to 0.8250 currently. Overnight, NZD/USD eked out modest gains, rising from 0.8220 to 0.8250.

The NZD failed to keep pace with a strengthening EUR and improved risk sentiment overnight.

In the short-term, expect the concerns over global growth to hamper moves in NZD/USD beyond 0.8400. Overnight, the S&P500 index and Euro Stoxx 50 index added 0.5% and 2.1% respectively. The VIX index (proxy for risk aversion) eased to 37.3 from 38.7 yesterday.

Yesterday’s Q2 manufacturing survey was disappointing, with sales volumes declining 0.7%. The data has seen us lower our Q2 GDP pick from 0.4% to 0.2%. However, the slower Q2 GDP doesn’t change our underlying story of a decent recovery.

We believe only a global recession will prevent the domestic recovery and need for the RBNZ to lift rates.

NZD/AUD continued to march higher overnight, rising from below 0.7950 to 0.7990 currently. Supporting the move higher was a dovish article on the RBA by noted watcher Mitchell (see below). Since the beginning of the week, the spread between market expectations of RBNZ-RBA policy over the next 12 months has widened in the NZD’s favour, from 164bps to 185bps currently. We suspect it will take a recovery in the Australian domestic data for this spread to narrow significantly, rather than just an improvement in global risk sentiment.

NZD/GBP rallied from 0.5190 to above 0.5220 overnight, as expectations of further quantitative easing from the Bank of England weighed on the GBP (see below). NZD/EUR spent the evening oscillating around 0.6020.

Looking to the day ahead, with no data releases locally expect the NZD to takes its cues from offshore. For the day ahead, we see support on NZD/USD at 0.8190 and resistance at 0.8290.

Majors

The USD fell against nearly all the major currencies as sentiment towards the European debt crisis stabilised. However, expect the trials and tribulations of the European debt crisis to continue as EU political leaders are yet to agree the best course of action. The USD index fell from 77.30 to 76.90 over the past 24 hours.

Trading on EUR/USD was volatile again overnight. The currency shed over 1 cent to 1.3560 during the early evening, before surging to above 1.3700 throughout the rest of the evening. The early weakness in EUR/USD was driven by speculation China may not agree to buy Italian debt, as previously rumoured. Adding to the negative sentiment were lingering concerns around the holding of peripheral European bonds by French banks.

Sentiment shifted back in favour of the EUR after it was announced the leaders of Greece, Germany and France would hold a conference call on Wednesday. Further bolstering sentiment was comments from German Chancellor Merkel, noting they will find a solution that meets the Finnish demands for collateral against loans to Greece.

The GBP underperformed against both the USD and EUR overnight, after Bank of England member Posen noted the “Monetary Policy Committee risks repeating mistake from 2008 of waiting too long for more QE”. UK CPI data for August was inline with expectations at 0.6%m/m. Several analysts noted the high CPI was not sufficient to quell expectations of further quantitative easing from the BoE. Over the course of the evening, GBP/USD fell to a low of 1.5760, but has recovered in the early hours of this morning back to 1.5820.

Despite improved risk sentiment, AUD/USD struggled to keep pace with the rising EUR. Some of the AUD weakness appears to be related to a dovish article from noted RBA watcher Mitchell, noting that "if increase in unemployment is sustained RBA would need to shift its tightening bias to rates on hold or cut them". AUD/USD is currently trading at 1.0330 after hitting an overnight low of 1.0260.

Expect the focus to remain on the European debt crisis for the night ahead. On the data front, we have Eurozone industrial production and US retail sales.

Fixed Interest Markets

NZ interest rate markets were relatively quiet, with yields generally flat to down 2bps. Overnight, a modest recovery in risk appetite helped US and German 10-year yields inch higher.

NZ 2-year swap yields opened lower yesterday, but crept back over the day to close virtually unchanged at 3.24%. They remain bobbing along the bottom of the range they have traded in since late-March. A relatively hawkish statement at tomorrow’s RBNZ meeting will be needed to see yields bounce off these lows. 10-year swap yields declined 2bps, to 4.59%, leaving the 2s-10s spread at 135bps.

In the slightly more risk seeking environment overnight, demand for “safe haven” US Treasuries declined. US 10-year yields rose from 1.94% to 2.0%. German 10-year yields initially dropped as low as 1.68%, before moving up to 1.80%.

An auction of 3.9b Italian 5-year bonds yielded 5.6%, up from 4.93% at the last auction in mid-July. Italian 10-year bond yields have risen to 5.71%, their highest level since early August, when the ECB began purchasing bonds, in order to temper rises in yields.

As speculation regarding the soundness of the European financial sector continues to swirl, measures of banks’ reluctance to lend to each other have risen. In recent days, the Eurobor-OIS spread (a measure of bank funding costs) has risen above 80bps, the highest level since March 2009.

There are no key NZ data releases today. Expect markets to consolidate today ahead of the RBNZ meeting tomorrow. We expect the RBNZ to remain on hold, but to restate its intention to remove its 50bps ‘insurance’ cut, when global uncertainty recedes.

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

Mike Burowes and Kimberly Martin are part of the BNZ research team. 

All its research is available here.