With the NZ-US 3-year interest rate differentials at around 340 bps, historical correlations suggest the NZ$/US$ cross rate should be above 85c

by Mike Jones

NZ Dollar

The NZD has slipped to the bottom of the currency performance rankings over the past 24 hours. Having recovered back to almost 0.8180 yesterday, the NZD/USD was slammed back below 0.8130 overnight.

The kiwi’s underperformance is somewhat surprising given the clear strengthening in local fundamentals. Yesterday’s November ANZ business survey hit the turbo button. Headline confidence hit the highest level since early 1999. The details were strong too, particularly the labour market indicators which point to a sharp drop in the unemployment rate in coming quarters.

None of this was lost on the local market, which has ratcheted up the odds of a January RBNZ rate hike to around 40%. The associated 2-4bps lift in the local swap curve yesterday has seen NZ-US 3-year swap differentials widen out to the highest level since November 2010, around 340bps. Based on historical correlations, interest rate differentials at these levels are consistent with a NZD/USD above 0.8500.

The fact the kiwi thumbed its nose to all of this and sold off looks to be a reflection of weakness amongst the cross rates. Yesterday’s robust Australian capex figures saw the NZD/AUD give up a good chunk of this week’s gains. To us, this looks more like a healthy correction than a change in the trend and we suspect another assault on 0.9000 is likely (0.8930 currently).

NZD/GBP also succumbed to a bout of speculative selling overnight, following the Bank of England’s decision to wind back part of its stimulus programme. The breakdown through 0.4980 support saw speculative investors open a gaggle of fresh short positions.

For today, profit taking on short positions and snippets of local exporter hedging demand should help the NZD/USD trim its overnight losses. Solid support should kick-in around the 0.8115 overnight lows. Further ahead, we maintain our view that supportive local fundamentals will push the currency up towards our year-end 0.8400 forecast.

Keep an eye out for today’s building consent figures at 10:45am. We’re expecting a strong 5.1% monthly gain (1.7% market) which, if realised, would be the third consecutive monthly increase. There’s also RBNZ credit data to monitor at 3pm.

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Majors

The USD has mostly lost ground against the majors over the past 24 hours, albeit in holiday-thinned and generally subdued trading conditions. We suspect currencies will have to wait for next week’s top tier data (chiefly Friday’s non-farm payrolls) for firmer direction.

While US markets were closed for Thanksgiving, a cautiously upbeat tone filtered through Europe. European stocks notched up small gains (EuroStoxx 50 +0.3%) and the EUR/USD rose from below 1.3580 to above 1.3600.

Stronger-than-expected economic data certainly helped buoy the appeal of European assets. The rise in the Eurozone European Sentiment Index (from 97.7 to 98.5) beat expectations of 98.0 and amounted to the 7th consecutive monthly gain.

Still, German inflation figures were probably more of a factor in the EUR’s gains. The German November CPI came in at 1.3%y/y (1.2% expected), with the EU harmonised measure blipping back up to 1.6% from 1.2% in October.

This suggest tomorrow’s European CPI estimate will exceed surveyed expectations of 0.8%, potentially limiting the chances of a follow-up ECB rate cut next week. Recall, it was the weak October German CPI readings that prompted the October ECB rate cut.

Receding ECB easing expectations may see the EUR/USD continue to probe higher in the short-term. A break above resistance at 1.3630 would pave the way for a move back up towards 1.3800.

The GBP/USD also continued its strong run overnight, climbing a further ½ cent to 1.6340 – a 2-year high. This followed an announcement from the Bank of England (in its FSR) that the Funding for Lending scheme will be wound back, now that the UK recovery is gaining traction. This only adds to the positive signals coming out of the UK and should see the GBP continue to outperform in the short-term.

Looking ahead, there is little on the slate tonight likely to change anyone’s views. This may leave recent trends intact, with the EUR and GBP free to keep grinding higher. Japan will release the November manufacturing PMI today, with German retail sales likely to be the most closely watched data item tonight.

All its research is available here.