Expected Republican wins in US mid-term elections seen as 'market friendly'

By Mike Jones

It was onwards and upwards for the NZD last night. The tailwinds from a broadly weaker USD and a spurt higher in the AUD propelled the NZD/USD to the highest level since June 2007.

Yesterday’s 25bps RBA rate hike completely wrong-footed a market looking for another pause. But while Aussie economists sat around scratching their heads, the AUD once again set its sights on parity with the USD.

A sharp widening in AU-US interest rate differentials saw the 1.000 level eventually breached during the London trading session. As ever, the NZD/USD was happy to draft off the AUD/USD’s slipstream throughout the overnight session.

Another bout of broad-based USD weakness and ongoing demand from Asian real money accounts added to the supportive NZD picture, such that NZD/USD eventually climbed to a new 28-month high around 0.7740. It’s also worth noting, NZD/AUD reversed most of its post-RBA losses overnight. After plunging to nearly 0.7660 in the wake of the RBA decision, the NZD/AUD has since recovered to around 0.7730 as investors deduced the RBA’s rate hike increases the chances of earlier RBNZ tightening.

Indeed, according to OIS pricing, roughly 80bps of tightening is now expected from the RBNZ over the next 12 months, up from around 50bps at the start of last week. The NZD’s yield advantage has widened accordingly. NZ-US 3-year swap spreads increased to almost 350bps overnight, the highest since September 2008. Looking ahead, positive momentum and Friday’s close above 0.7650 portend further near-term NZD/USD gains.

However, tomorrow morning’s FOMC policy announcement looms large as key event risk for currency markets. Analysts are expecting a monthly pace of US$80b-$100b worth of quantitative easing to be announced. Should the Fed announce a less aggressive easing policy, a likely bounce in the USD would serve to knock the NZD/USD from its highs.

Majors

“Safe-haven” currencies like the USD and JPY suffered overnight as buoyant stock markets and a surprise RBA rate hike boosted investors’ risk appetite. Currency markets took direction from stock markets overnight, with most of this week’s big economic news due later in the week.

European equities posted gains of 0.6-1.1%, buoyed by a stronger than expected read on European manufacturing activity. The October manufacturing PMI rose from 54.1 to 54.6 (54.1 expected).

Meanwhile, in the US, the S&P500 and Dow Jones indices rose by 0.8% and 0.7% respectively as investors anticipated the Republican Party increasing its influence in the US Senate and House as the US mid-term elections get underway. Results from the elections are expected to filter in from mid-afternoon (NZT), but recent polls indicate the Republicans will take over the House of Representatives and reduce the Democrats majority in the Senate, a result widely seen as a “market-friendly”.

Against a backdrop of buoyant equity markets and upbeat economic data, investors ditched “safe-haven” currencies like the USD and JPY in favour of “growth-sensitive” currencies like AUD, NZD, and EUR. Not surprisingly, the AUD/USD was one of the night’s strongest performers following yesterday’s surprise 25bps rate hike from the RBA (taking the cash rate to 4.75%). AUD/USD jumped from below 0.9900 to fresh 28-year highs above 1.000, and EUR/USD climbed over 1% to around 1.4050.

GBP was one of the few currencies not to benefit from the broadly weaker USD. Indeed, a relatively dour reading of the UK PMI construction index (51.6 vs. 53.0 expected) limited GBP/USD gains to the 1.6080 region overnight. Nevertheless, speculation the Bank of England will announce additional quantitative easing measures at its Thursday meeting has receded of late, following an encouraging run of UK data.

Looking ahead, tomorrow morning’s (7:15am NZT) FOMC policy meeting is now front and centre for markets. Expect subdued trading as traders square positions and reduce risk exposures heading into the meeting.

The Fed is widely expected to kick-start a fresh round of asset purchases, but estimates of how much vary widely (the latest Reuters poll suggests a US$80b-$100b per month range of expectations) so higher volatility in the USD is likely following the announcement. We’ll also be keeping an eye out for headlines and results from the US mid-term elections from early afternoon.

* Mike Jones is part of the BNZ research team. 

All its research is available here.