Opinion: Demand for NZ$ firm as talk grows of OCR hike in 'coming months'

By Mike Jones Yesterday’s RBNZ meeting was suitably brief. We still can’t be sure whether the RBNZ will pull the trigger in June or July. That shouldn’t be a surprise as it’s abundantly clear the Reserve Bank is not so sure yet either. The Bank’s statement was about as ambivalent as possible about the specifics while being absolutely consistent with past commentary that the tightening cycle will start at the middle of this year. To us, June/July still looks like a 50/50 call. The RBNZ’s decidedly open-ended statement disappointed those looking for a smoking gun to justify a June hike. The NZD suffered a brief setback as a result, with NZD/USD slipping below 0.7200 and NZD/AUD sliding ½ cent to 0.7750. However, these moves were reversed and then some overnight. Investors’ appetite for risk bounced back as European leaders finally seemed to grasp the magnitude of the Greek fiscal crisis. A new, improved rescue package for Greece has now been promised “within days”, underscoring strong gains in equities and commodity prices overnight. Our risk appetite index (which has a scale of 0-100%) bounced from 61% to nearly 67%. With risk appetite again on the improve, investors shunned “safe-haven” currencies like the USD and JPY in favour of high yielding ‘growth-sensitive’ currencies like the NZD and AUD. Strong appetite for the NZD was noted from both real money and short-term speculative accounts last night. And with the RBNZ confirming interest rates are set to rise “over coming months”, NZD demand was particularly strong relative to low yielding currencies such as EUR and JPY. NZD/JPY climbed from 67.20 to almost 68.20 and NZD/EUR re-tested 26-month highs around 0.5470. As a result, NZD/USD finished the night close to 3-month highs around 0.7230. For today, easing fears about European sovereign solvency and improving risk appetite are expected to limit dips in NZD/USD to the 0.7150/60 region. A daily close above 0.7255 would confirm the positive NZD momentum. Majors The USD pared some of its recent gains last night. Reduced pessimism about the European sovereign debt crisis bolstered risk appetite, and investors trimmed positions in “safe-haven” currencies like the USD and JPY. Markets’ frayed nerves were soothed by reassurances from European leaders that Greece’s rescue package will not only be very large (€100b-120b), but also timely. EU official Rehn said the EU will complete talks on Greece “within days”. German resistance to a Greek bailout also appears to have weakened. Germany’s largest opposition party said it would not stand in the way of Greek aid decision, so long as banks shoulder some of the aid burden. Greek-German 10-year bond spreads plunged almost 100bps to around 600bps overnight, with market chatter suggesting a new aid package will be announced as early as Monday. While no panacea for the region’s debt issues, the prospect of a fresh bailout package for Greece had the effect of shoring up EUR sentiment, for now. Some robust European data also helped in this regard. European economic confidence increased to 100.6 (99.4 expected) and German unemployment unexpectedly fell (to 7.8% in April vs. 8.0% expected). After testing 1-year lows of 1.3120 yesterday, EUR/USD ground up to nearly 1.3280 last night. European equity markets rebounded 0.6-1.4%, while the S&P500 is currently up around 1.3%. Not only were markets in the US heartened by the FOMC’s noticeably more upbeat take on the US economy, but hopes of a sustainable US recovery are being supported by healthy US corporate earnings. Of the 305 S&P500 companies that have reported to date, 83% have beaten analyst forecasts. Against a backdrop of buoyant equity markets and recovering risk appetite, investors trimmed positions in “safe-haven” currencies like the USD and JPY last night. Despite lingering election concerns, GBP/USD was dragged up to almost 1.5350, largely on the coat tails of the firmer EUR. To be fair, a 1% increase in UK house prices in April (0.4% expected) didn’t do GBP sentiment any harm. Meanwhile, a rebound in commodity prices (oil prices are up over 2%) encouraged demand for ‘growth-sensitive’ currencies like CAD, AUD and NZD. USD/CAD again closed in on parity, while AUD/USD climbed above 0.9250, helped by traders pricing a higher chance of an RBA interest rate hike in May (current pricing is consistent with about a 50% chance of a 25bps hike). US March quarter GDP data tonight will confirm whether or not the strong momentum from Q4 continued into Q1. In the absence of a clear downside surprise, dips in the USD index are expected to be limited to 81.30 in the short-term. *All of the research produced by the BNZ Capital team of economists is available here