AUD is now more risk sensitive than the NZD, means the NZD/AUD appreciates during periods of risk aversion and market stress

by Mike Jones

NZD

Markets went back into panic mode overnight.

The NZD/USD reversed all of its gains for the week as rising risk aversion prompted a generalised shunning of risk assets. The NZD/USD currently trades around 0.7540, around a cent below levels prevailing this time yesterday.

The NZD continues to dance to the beat of global risk appetite and equity market sentiment.

As the news from Europe has continued to worsen over the past 24 hours, risk appetite has come under additional pressure.

Global equity markets are a sea of red, and our risk appetite index (scale 0-100%) has fallen 5 percentage points to 41.1%.

General risk-off sentiment has also weighed on commodity prices. The CRB index (a broad index of global prices) declined 1.7% overnight, to be down 11% in May to date.

Against a backdrop of equity market weakness and sliding commodity prices, investors took flight from risk-sensitive currencies like the NZD, storming back into safe-haven alternatives like the USD and JPY. The NZD/JPY skidded from above 60.50 to around 59.60, helping drag the NZD/USD back below 0.7550.

Still, the AUD has tended to suffer more than the NZD over the past 24 hours. NZD/AUD has continued to climb, in line with our expectations (‘fair-value’ is currently estimated to be 0.7700-0.7900).  In part, this reflects yesterday’s weak Australian retail sales figures (-0.2%m/m vs. +0.2% expected).

In addition, we’ve found the AUD is now more risk sensitive than the NZD, reflecting its higher yield. This means the NZD/AUD has tended to appreciate during periods of risk aversion and market stress.

Today’s NBNZ business confidence survey looks set to be the highlight of the NZ data week. We are looking for the survey to peel back a bit from current lofty levels consistent with 4-6% NZ GDP growth. We are forecasting something closer to 2.5%. We doubt the survey will have much of an impact on the NZD though (it hardly ever does). Asian equity market sentiment will probably be more important for NZD/USD direction on the day.

Initial support on the NZD/USD is expected at 0.7500. Bounces towards 0.7650 will continue to be met with strong selling interests.

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Majors

The USD and JPY soared overnight, as rising risk aversion sent investors scrambling back into ‘safe-haven’ assets. The trade-weighted USD climbed 0.5% to almost 83.00.

The source of market stresses remains the same – Europe. The EU crisis took another turn for the worse overnight. All the while, European policy makers are standing by, seemingly at a loss as to how to stem the rot.

The negatives came thick and fast. Greek political polls showed the anti-bailout Syriza party is again ahead of the pro-bailout New Democracy party, piquing Grexit fears. A disappointing Italian bond auction saw bond yields soar. Data-wise, both US pending home sales (-5.5% vs. 0.0% expected) and Eurozone economic confidence (90.6 vs. 91.9 expected) undershot market expectations noticeably.

Rising peripheral European bond spreads (the Spanish/German 10-year spread hit a fresh high around 540 bps) soon inspired broader market panic. Global equities slipped 1.0-2.6%, oil prices plunged 3.2% (to US$88/barrel) and the VIX index (a risk aversion proxy) climbed from 21% to almost 24%.

Two-year German government bond yields fell to 0%.

Investors’ generalised shunning of risk assets produced the expected reaction in currency markets. The USD and JPY outperformed, with the heaviest toll taken on the ‘pro-risk’ AUD and NZD. Around 1½ cents was also carved off both the GBP and EUR, the latter declining to fresh 22-month lows below 1.2400.

Looking ahead, we’re now approaching the business end of the week, with US Q1 GDP, European and US manufacturing indices, and US non-farm payrolls all due in the next two days. Given the negative sentiment pervading markets, downside surprises are likely to have the biggest influence on currencies.

Positive surprises may provide a temporary circuit breaker to risk aversion. But what markets really want is definitive policy action from Europe. In the absence of such, and failing a strong run of economic data, we are likely to see ongoing demand for the USD and JPY.

All its research is available here.