Dour set of European data puts euro on back foot and reinforces economic headwinds facing region

by Mike Jones

NZD

The NZD/USD has spent the past 24 hours consolidating in a 0.7530-0.7600 range.

The AUD has outperformed following yesterday’s RBA meeting. The cash rate was cut 25bps to 3.5%. While this was in line with the consensus expectation, the market had priced a reasonable chance of a larger 50bps cut.

As the extra easing was priced out of the curve, the AUD/USD climbed to almost 0.9800. NZD/AUD skidded back below 0.7750 and continued to trade heavily overnight.

Looking ahead, our NAB colleagues expect the RBA to sit on its hands for the next two months and assess the incoming data (confidence, retail sales, employment and Q2 CPI).

Overall, the data flow looks set to remain soft. If European events turn decidedly worse a July cut will be on the table, but otherwise a further 25bps cut in August remains the more likely outcome.

Overnight, currency markets struggled for direction a little. But a mild easing in risk aversion (see Majors) kept the NZD and AUD on a relatively firm footing, as did sporadic bouts of NZD/EUR and AUD/EUR buying.

Last night’s Fonterra milk price auction also helped shore up sentiment towards the NZD. Average dairy prices shot up 13.5%. We’d expected only a small increase.

We’ve been suggesting dairy prices might find a floor through mid-2012 and even rise a bit into year end. Given the current global backdrop, last night’s result is encouraging for the new season’s payout. But we are reluctant to read too much into one result, especially given the recent degree of volatility.

We noted yesterday the NZD volatility has been on the ascendancy of late. We’re bracing for more of the same over the next day or so as a slew of data and events hits markets. On the home front, the Government publishes its Financial Statements for April today.

Then we see the Q1 building figures, which we expect to register another reasonable gain in the order of 3.0%. Still, we’ll probably see more NZD reaction to Australian GDP data, due 1:30pm (NZT). The market expects a 0.6%q/q GDP expansion.

Tonight also looks busy with Eurozone GDP, the latest ECB policy decision, and the Fed’s Beige Book. In the short-term, we continue to expect NZD/USD sellers to emerge on bounces towards 0.7650. Initial support is eyed at 0.7500.

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Majors

A cautious return of risk appetite filtered through financial markets overnight. The ‘risk-sensitive’ AUD, CAD, and GBP outperformed at the expense of the USD and EUR.

Hopes fresh policy stimulus will be announced to shore up the global economy bolstered market sentiment. Vague chatter a recapitalisation plan for European banks could be in the wings, and an ‘emergency’ G7 phone conference helped spur a small relief rally across equity markets.

Commodity prices and bond yields also edged marginally higher. The G7 phone call didn’t come to much in the end (Spain was again encouraged to request a bailout for its financial sector), but markets have held their small gains. The S&P500 is currently up around 0.6% and the CRB commodity price index a more modest 0.2%.

Consistent with fading risk aversion, risk sensitive currencies outperformed the ‘safe-haven’ JPY and USD. The AUD/USD led the gains, reaching an overnight high of almost 0.9800.

Notably, the EUR failed to share in the more upbeat sentiment. A dour set of European data – including weak European services PMIs, retail sales (-1.0%m/m vs. -0.1% expected), and German factory orders – reinforced the economic headwinds facing the Eurozone.

From above 1.2520, the EUR/USD skidded back below 1.2450, dragging other European currencies lower (NOK, SEK, and CHF), and lending support to the USD more broadly.

Looking ahead, European economic underperformance should maintain downward pressure on the EUR in coming weeks, whatever the political noise.

A retest of recent 1.2350 lows in EUR/USD looks likely. We’ll get more insight into this tonight with German industrial production (-1%m/m expected) and Eurozone GDP figures (0.0%q/q expected) due.

The Fed’s Beige book will also be released tomorrow morning.

However, the real focus for markets will be the ECB policy decision. On balance, the market expects rates to be left unchanged at 1%. But there is a lot of chatter about the potential for the ECB to a) lower rates or b) announce further LTROs (cheap cash for banks).

Indeed, several economists (11/59) are picking a 25bps rate reduction. If the ECB does choose to sit on its hands, the market may express its disappointment through a lower EUR.

All its research is available here.