EU sovereign bond auctions go well; US earnings as expected

By Mike Jones

NZD

The NZD/USD has continued its steady ascent over the past 24 hours, rising above 0.7950 overnight for the first time since November.

Positive sentiment has washed through global markets over the past 24 hours. A series of successful European sovereign bond auctions, a solid start to the Q4 US earnings season, and hopes for Chinese monetary stimulus underpinned a noticeable improvement in investors’ risk appetite.

Global equity markets notched up gains of 0.5-2.7% and our risk appetite index (which has a scale of 0-100%) jumped from 48.4% to 50.1%. Receding fears about the global outlook also saw commodity prices rise – the CRB index (a broad index of commodity prices) climbed 1.2%.

Improving risk appetite and rising commodity prices saw investors ditch the “safe-haven” appeal of the USD in favour of the higher-yielding AUD and NZD. Technical buying following the NZD/USD’s break of the 100-day moving average (at 0.7890) has also supported the NZD/USD over the past 24 hours.

Yesterday, the NZD/EUR climbed above 0.6200 – the highest level since the Euro was founded in 1999. With this exchange rate now in uncharted territory, there is considerable interest in where it will go next.

As long as the global economy remains on a relatively solid footing and the worst is avoided in terms of the European crisis, the NZD/EUR will remain well supported. Yes, bouts of risk aversion will knock the currency lower from time to time, but we think the more positive NZD fundamentals will ultimately shine through.

In this regard, it’s worth noting that NZ economic growth is forecast (by us and the consensus) to outstrip that of Europe by a significant margin over the next couple of years.  NZ sovereign debt levels are also much more favourable and we expect the NZD will maintain a healthy yield advantage over the EUR for the foreseeable future (NZ-EU 3-year swap differentials currently sit at +160bps).

So how high could the NZD/EUR go?

With the currency now in uncharted territory, predictions are all the more difficult. Purchasing power parity analysis can provide some big-picture guidance. Historically, currencies tend to reach their cyclical peak (trough) 20-30% above (below) their PPP equilibrium. We estimate the current NZD/EUR PPP equilibrium to be around 0.5100. So, from this perspective, NZD/EUR could appreciate further to as high as 0.6500-0.6600 and still be consistent with historical trends and cycles.

Majors

Fading concerns about a sharp slowing in global growth have bolstered demand for risk sensitive assets over the past 24 hours. Investors shunned the “safe-haven” USD and JPY in favour of high-beta “growth-sensitive” currencies like NZD, AUD, and CAD.

The more positive mood began in Asia. Asian stocks notched up solid gains yesterday, led by a 2.7% increase in the Shanghai index, after weaker-than-expected Chinese import figures (11.8%y/y vs. 18.0% expected) sparked speculation easier Chinese monetary policy could be in the offing. The Hang Seng Index rose 0.73% and the Nikkei was up around 0.4%.

European and US equities soon joined the fray. Not only did European sovereign (Greece, Austria, Netherlands and the UK) bond auctions all go to plan, but the US corporate earnings season got off to a encouraging start with Aluminium producer Alcoa providing an upbeat outlook for global demand.

Falling European sovereign bond spreads helped the EuroStoxx 50 index rise 2.7% while the US S&P500 is currently up around 0.9%. The VIX index (a proxy for risk aversion based on the implied volatility of the S&P500) dropped a point from 21 to 20.

Buoyant stock market sentiment and easing risk aversion saw investors shun “safe-haven” currencies like the USD and JPY in favour of higher-yielding alternatives like the AUD and CAD. USD/CAD skidded below 1.0180 from 1.0240 24 hours earlier, and the AUD/USD climbed around ½ cent to almost 1.0350.

Ratings agency Fitch said last night that there is a good chance Italy’s sovereign rating will be downgraded shortly, but also said France should be able to hold onto its AAA rating for now. The lack of more dire European news saw the recent paring of EUR short positions continue. EUR/USD ground up to 1.2810 before dribbling lower.

Looking ahead, whether or not the EUR/USD can hold onto its recent gains will depend on the outcome of upcoming Spanish and Italian bond auctions, and Thursday night’s ECB meeting. Despite the recent squeeze higher, we remain of the view the EUR/USD is in the midst of a broader downtrend and near-term rallies should be limited to 1.2950. Tonight, there is limited economic data on the calendar but a swathe of Fed speak should be watched for hints the Fed is still thinking about quantitative easing mark III.

All its research is available here.