RBNZ, RBA rate decisions in focus; Talk of a euro collapse dismissed as "explosive claptrap"

By Mike Jones

The NZD danced to the tune of global factors last week. While global risk aversion initially kept the NZD under pressure, a recovery in risk appetite and a broad-based weakening in the USD saw the NZD/USD finish the week around 2% stronger.

After keeping “risk sensitive” currencies like the NZD under downward pressure for the early part of last week, European sovereign debt jitters faded noticeably towards the end of the week. While steady bond buying from the ECB certainly helped, investors also focused on the positives from a swathe of upbeat global manufacturing data. Indicative of recovering risk appetite, equity markets surged, commodity prices pushed higher, and credit spreads narrowed.

The MSCI World Equity Index finished the week some 3% higher, while oil prices surged 6.5% to nearly US$90/barrel – a 2-year high. Recovering risk appetite and rising commodity prices bolstered demand for “growth-sensitive” currencies like the NZD, at the expense of “safe-haven” currencies like the USD and JPY.

On Friday, the NZD/USD received a further leg-up from a bout of broad-based USD selling. November’s surprisingly weak US non-farm payrolls (39k vs. 150k expected) triggered a 4-10bp slide in US bond yields, weighing on the USD and contributing to a widening in NZ-US interest rate differentials. Indeed, NZ-US 3-year swap spreads rose from 312 to 320bps. Looking ahead, this week’s global events calendar looks positively dead compared to all the excitement of last week.

As a result, we wouldn’t be surprised to see the NZD take on a more local focus this week, particularly given the approach of Thursday’s RBNZ Monetary Policy Statement. Like the OCR Review before it, Thursday’s meeting is likely to play things cool. The local recovery continues to frustrate, for the most part, and renewed global uncertainties also argue for the RBNZ to sit with its stimulative 3.00% OCR setting for the near future. As for timing, the RBNZ could start up again in March (as remains our core view), or conceivably wait until June.

However, with market pricing already centred on a June resumption of the tightening cycle, we’d need to see a markedly dovish statement from the RBNZ to send cash rate expectations and the NZD lower.

All up, we suspect NZD/USD rallies will be limited to around 0.7800 this week. Not only do further sharp falls in the USD look unlikely, but NZD/USD already looks overstretched on the basis of “fair-value”. Our short-term valuation model currently suggests a 0.7400-0.7600 “fair-value range”.

Majors

The USD depreciated against nearly all of the major currencies on Friday night as surprising weakness in November non-farm payrolls triggered a sharp fall in US bond yields. The report showed US employment expanded a meagre 39k in November, in contrast to analysts’ expectations for a 150k jobs gain. The unemployment rate shot up to a 7 month high of 9.8%. The weak jobs report reignited expectations the Fed will maintain its aggressive easing stance or even expand its quantitative easing policy further.

As a result, US bond yields plunged, weighing on the USD. Two-year Treasury yields fell around 10bps to 0.47% and 10-year yields dipped 4bps to 3.0%.

With the USD in retreat, most of the major currencies were propelled higher. USD/JPY dived from 83.80 to around 82.60, GBP/USD climbed from 1.5600 to almost 1.5880 and EUR/USD surged almost 2 cents to above 1.3400. Besides the broadly weaker USD, reduced fears about European sovereign solvency also helped underpin the EUR on Friday. Rumoured steady bond buying by the ECB helped spur a broad-based narrowing in peripheral European bond spreads.

The spread between Portuguese and German 10-year government bonds dropped 25bps to 307bps, while the Irish equivalent slipped 40bps to 528bps. Eurogroup chairman Jean-Claude Juncker also said "the euro will survive” the latest round of sovereign debt jitters and talk of a euro collapse was "explosive claptrap". Last week was crammed full of event risk, but the coming week is a good deal quieter. As a result, currencies may struggle to find the impetus to break out of their recent ranges.

There isn’t a lot in the way of key data to watch out for. Instead, central bank meetings will likely arouse the most interest. The RBNZ, RBA, Bank of England, and the Bank of Canada are all due to meet, none of which are expected to alter policy settings. As ever though, the tone of their respective policy statements will be of interest to currency markets. The European sovereign debt crisis seems likely to remain in the headlines. Following last week’s Irish bailout, attention has turned to whether Portugal will call on the EU-IMF for something similar.

This seems likely unless Portuguese borrowing costs fall in a material fashion. Given the potential for further deterioration in Europe’s debt crisis, we wouldn’t be surprised to see the EUR surrender some of its recent gains this week. Initial resistance on EUR/USD is eyed on rallies towards 1.3490.

* Mike Jones is part of the BNZ research team. 

All its research is available here.