NZ$ yield advantage increases meaning chances of RBNZ cutting OCR are slim

by Mike Jones

NZD

After finishing last week on the front foot, the NZD has continued to climb this morning following the weekend’s Spanish bank bailout. Having ended last week around 0.7700, this morning’s boost to risk appetite has seen the NZD/USD spike to around 0.7760.

All of the major currencies are climbing against the USD and JPY this morning following a trifecta of ‘risk positive’ news over the weekend. This sets the scene for a strong performance from the NZD and AUD this week.

However, much depends on how equity markets and European bond markets react to the news. In the short-term, we’d expect the NZD/USD to run out of steam towards 0.7815.

Still, there is no doubt NZ fundamentals have improved. First, risk appetite has pulled back from the brink, consistent with the stabilisation in the global backdrop last week.

Our risk appetite index (scale 0-100%) finished the week up at 46%, from 31.7% on Monday. Second, last week’s 13.5% jump in average dairy prices was perhaps an early sign NZ’s commodity export prices are close to finding a floor. Finally, the NZ dollar’s yield advantage has increased as OIS markets have pared bets on RBNZ easing. NZ-US 3-year swap differentials now sit at around 205 bps, up from around 180bps at the start of last week.

All of this tends to accord with our oft-stated view that dips in the NZD/USD are likely to be short-lived in the absence of clearer signs of contagion from Europe to the rest of the world. Yes, global growth is slowing and the risks are to the downside but, to date, forecasts remain around trend. 

Moreover, we still believe the NZ economy is on a modest growth path and there is no compelling reason for the RBNZ to cut interest rates. As long as the global picture holds in ok, these factors should continue to support the NZD through a positive yield differential. Our year-end forecast remains 0.8100.

Domestically, the RBNZ’s June Monetary Policy Statement will hog the limelight this week. We expect rates to be left on hold at 2.5%. The market prices a small (~20%) chance of a 25bp rate cut. The latest global and NZ data has probably been a tad weaker than expected by the RBNZ. However, large drops in mortgage interest rates and a NZD almost 4% below RBNZ forecasts have eased financial conditions substantially already.

Nonetheless, the Bank does seem likely to delay its forecast OCR hikes to 2013 H1, from the late-2012 start it signalled in March.

The knee-jerk currency response to an on-hold decision would likely see the NZD higher, as near-term easing expectations are priced out of the curve. However, swings in risk sentiment will remain the bigger driver this week.

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Majors

A trifecta of ‘risk positive’ news over the weekend has seen the ‘safe-haven’ USD open the week on the back-foot.

The EUR is outperforming – EUR/USD has opened the week up over a cent around 1.2630. The AUD/USD is up ¾ cent around 0.9985, and USD/JPY has climbed to 79.70 as the JPY underperforms.

On Saturday, the Spanish government bowed to the inevitable and accepted a €100b EU aid package to recapitalise their banking system.

The loans are likely to come from a combination of the EFSF and ESM. Unlike the packages for Ireland, Portugal, and Greece, there will be no IMF involvement, so Spain will not be subject to additional austerity conditions from the troika.

However, the loans will be channelled through the sovereign so, technically, Spanish sovereign debt will increase. And the Spanish sovereign still needs to finance itself through the bond market, which should keep upward pressure on Spanish bond yields.

Nevertheless, the bailout does allay immediate fears of a banking crisis and contagion to the rest of Europe. This is the main reason the EUR is leading a rally in the majors this morning.

Following Thursday’s surprise Chinese rate cut, investors were wary of weakness from the weekend’s Chinese data (industrial production, retail sales, and exports). In the event the data wasn’t as bad as feared. Chinese CPI also undershot expectations (3.0% vs. 3.2% expected).

Overall, it seems Chinese data is in a sweet spot of slowing enough to warrant policy stimulus, but not enough to be consistent with the feared ‘hard landing’. This is supportive of risk appetite.  

Completing the trifecta of pro-risk news, weekend German media reports suggest European policy makers are working on plans for a “genuine fiscal union”, under which European countries’ national bonds would eventually be replaced with euro bonds.

For today, easing fears of European contagion and the likelihood of gains in Asian equities should keep risk-sensitive currencies perky. Whether the rally can be sustained may depend on tonight’s reaction from the European bond market to the weekend’s Spanish news.

All its research is available here.