Fresh Euro crisis concerns hit equity and curency markets; NZ long term yields rise in response to credit downgrade

By Mike Burrrowes and Kymberly Martin

NZD

NZD/USD continued to lose ground on Friday night, falling to around 0.7600 currently. This is the lowest level on NZD/USD since April this year. The declines on Friday night were driven by further concerns around the European debt crisis, leading to a spike in risk aversion.

NZD/AUD declined sharply during the day on Friday, after NZ’s sovereign credit rating was downgraded by Fitch and S&P. However the cross recovered from 0.7820 to around 0.7870 currently. For now the ratings downgrade seems to have had a more limited impact on the NZD, relative to the reaction seen in NZ government bond markets (see below fixed interest section below).  

The NZD was better supported relative to the weakening EUR on Friday night. NZD/EUR bounced from below 0.5640 to around 0.5680 currently. NZD/GBP dribbled lower throughout the evening to be trading around 0.4880 currently.

Looking to the week ahead, tomorrow’s we have the QSBO for Q3. As for one of NZ’s more immediate vulnerabilities we’ll be watching this week’s commodity price updates extremely closely. In this regard, today we have the ANZ commodity indices for September. On Wednesday morning we have the Fonterra’s auction, for which we wouldn’t be surprised to see a larger fall in dairy prices than we’ve seen to date. But the lower NZD will help to temper the declines in local currency terms.

For the day ahead, initial support on NZD/USD is eyed at 0.7650 and resistance at 0.7750.

Majors

Another bout of risk aversion spurred the USD higher against all the major currencies. The sour mood on Friday night was again led by further concerns over the European debt crisis.

Risk sensitive assets lost ground across the board on Friday night. In equities, the S&P500 index and Euro Stoxx 50 index lost 2.5% and 1.5% respectively. For the quarter, the S&P500 index and Euro Stoxx 50 index ended down 15.6% and 24.2%. Our risk appetite index fell to 24.3 from 25.9. The CRB index (broad index of global commodity prices) fell a further 2.5% and is now at its lowest level since November 2010.

EUR/USD fell heavily throughout the evening, falling from above 1.3530 to below 1.3400. Sentiment towards the EUR waned after German Finance Minister Schaeuble gave a very strong hint Germany will not contribute any more money to the EFSF.

Further dampening sentiment were rumours a “top official” at the ECB had suggested the Troika (IMF/EU/ECB) could require private holders of Greek bonds to accept a whopping 75% haircut. Markets will be looking for comments on this from the Eurozone finance ministers who meet on Monday and Tuesday. We assume the ministers will discuss how, and if, to expand the EFSF.

Adding to the event risk on the EUR for the week, we have the ECB decision on Thursday. The OIS market is currently fully priced for a 25bp cut and pricing a 15% chance of a 50bp cut. Expect some comments from ECB President Trichet at the accompanying press conference on providing liquidity to the European banking system.  

The GBP was better supported relative to the EUR. GBP/USD closed just below 1.5600, after starting the day around 1.5620. Looking to the week ahead, the key risk for the GBP will be Thursday’s Bank of England meeting. While no move in rates is expected, there is a risk the MPC could announce another round of QE. We think the MPC will wait until November to announce QE.

The risk-off sentiment has seen the AUD, CAD and NZD underperform. AUD/USD shed almost 1 cent to 0.9660, near its lowest level since December 2010. Aside from developments offshore, the market is focused will be focused on Tuesday’s RBA meeting. With the RBA widely expect to leave rates on-hold, the focus will be on the tone of the accompanying statement.

Looking to the week ahead, expect the trials and tribulations of the European debt crisis to keep trading in FX markets volatile. It’s a busy week for central banks, with RBA on Tuesday, ECB and BoE on Thursday evening and Bank of Japan on Friday. The highlights on the data front will be the monthly PMI manufacturing updates for the Eurozone, US and UK tonight. US non-farm payrolls on Friday evening will also be a highlight.

Fixed Interest Markets

NZ yields rose on Friday after downgrades to NZ’s sovereign ratings from Fitch and S&P. Curves steepened.

Ratings agency S&P downgraded its rating for NZ on Friday afternoon, following on from the downgrade by Fitch early in the morning. S&P lowered NZ’s long-term foreign-currency credit rating to AA from AA+. It lowered the long-term local currency rating to AA+ from AAA. The outlook was changed to ‘stable’ from ‘negative’.

Of the 3 key rating agencies, Fitch and S&P now have NZ’s sovereign long-term foreign currency rating at AA, two notches below Moody’s rating of Aaa.  Fitch and S&P’s long-term local currency rating is at AA+, one notch below Moody’s at Aaa. Moody’s reiterated its current ratings on Friday morning.

NZ bond yields closed 5bps higher at the short-end and 11bps higher at the long-end. The yield on 13s closed at 2.87% and 21s at 4.42%. The rise in yield represented the market adding additional ‘risk premium’ to NZ bonds. This is to cover the perceived higher risk of sovereign default suggested by the downgrade.  Similarly, NZ CDS spreads (a measure of default risk) rose to a new high of 112, from 104. The market had also been well-supplied with bonds ahead of the downgrade, after the large NZ$1b DMO tender on Thursday.

Swap yields also moved higher.  2-year swap yields closed up 2bps at 3.12% and 10-year yields closed up 9bps at 4.51%. This has seen 10-year EFP close slightly to 8bps.

Overnight on Friday, US 10-year yields drifted down from just under 2.0% to 1.91%, as risk appetite waned. Over last week, yields had risen from 1.85% to as high as 2.05% midweek, before creeping lower thereafter. Yields however, are now someway off their recent lows of 1.67%. They are likely underpinned by some small bright spots on the US data front, such as Friday’s upside surprise to the Chicago PMI (60.4 vs. 55.0 expected) and University of Michigan Confidence (59.4 vs. 57.8 expected).

It is a light week ahead for NZ data. The RBA meeting on Tuesday will be closely watched.  Although the RBA is expected to remain on hold at 4.75%, any accompanying comments will be important to a market that still looks for meaningful cuts (130bps) from the RBA in the coming year. We do not expect cuts.

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

Mike Burowes is part of the BNZ research team. 

All its research is available here.