BNZ risk appetite index at record highs ahead of major round of US Federal Reserve speeches

By Mike Jones

The NZD/USD has spent the past 24 hours consolidating in a relatively tight 0.7680-0.7720 range. Ebullient sentiment continued to seep through global markets overnight. Helped by a string of upbeat US earnings announcements, US stock markets rose 0.7-0.9% to fresh 31-month highs.

The copper price soared to another record high, and US bond yields continued to climb in the wake of Friday’s surprise drop in the US unemployment rate.

Our risk appetite index (which has a long-run average of 50%) held at recent highs around 75%. While the generally buoyant risk backdrop kept ‘growth-sensitive’ currencies like the NZD underpinned, a broadly stronger USD ensured NZD/USD gains were limited to around 0.7720 overnight.

Indeed, the USD strengthened against most of the major currencies overnight, reflecting the ‘fundamental’ support from surging US bond yields. 10-year US Treasury yields have risen some 30bps over the past week to the highest level since May 2010.

As a result, the NZD/USD’s interest rate differential has fallen sharply. From above 290bps at the start of last week, NZ-US 3-year swap spreads fell below 260bps overnight. This is the lowest since August 2009, when the NZD/USD was trading below 0.7000. The reduced yield appeal of the NZD/USD means we doubt rallies above 0.7800 will be sustained this week. Short-term support is eyed on dips towards 0.7560.

Speeches from a slew of Federal Reserve officials (including Chairman Bernanke) this week will hold important clues on whether US bond yields and the USD can sustain their recent gains. The packed schedule of Fed speak kicks off tonight with speeches from Lacker, Lockhart and Fischer. Overall, we expect USD sentiment to dictate direction in the NZD/USD this week. This is particularly so given a notably quiet local data calendar.

Majors

Currency markets were without dramatic moves overnight. The USD index crawled higher from around 77.90 to 78.20 during the night. Without any significant data releases yesterday, currencies appeared to remain in a holding pattern, in the backdrop of broad positive sentiment in other markets. Commodities were generally higher, with the exception of the oil price which continues to decline after its Egypt-related spike. Equity markets continued their ascent with European markets closing up almost 1% while the S&P500 is up around 0.80%.

At around 1320, the S&P500 is now back at levels last seen in June 2008. Financials were the best performing US equity sector overnight, while cyclical sectors that are leveraged to economic growth, such as IT and industrials, also drove the market higher. Optimism regarding cyclical growth is also represented by the recent rise in US bond yields. Overnight, US 2yr and 10yr bond yields rose to levels not seen since around May last year, at close to 0.785% and 3.68% respectively.

An unwinding of short speculative positioning may have also contributed to the recent USD gain. CFTC data shows that the size of net short USD position rose by a third in the week to February 1. In value terms, it jumped US$6.3bn to US$25.5bn, the largest in three months. As such, USD positioning by the speculative community cautions against expecting too much further broad-based USD weakness near-term, in the absence of some terrible fundamental news for the greenback.

Elsewhere, the AUD was relatively range bound overnight trading between 1.0120 and 1.0160, before ending the night around 1.0130. The European currencies were equally unexciting overnight. The GBP spiked higher during the night but ended largely where it had started around 1.610. The EUR was a bit weaker overnight trading around 1.3620 early in the night before dropping off to 1.3550. Attention on the ‘risk’ of Egypt declined with the VIX (a measure of risk aversion) falling further to around 16%.

Egypt managed to issue some short-term Government debt overnight although it was forced to reduce the size of the placement from €15bn to €13bn, due to lack of investor interest. There is not too much data out of the US today, as the market waits for Bernanke to testify to the House tomorrow.

The UK releases retail sales and house price data today, which will give some colour on UK consumption. German industrial production released today will provide some detail on how Europe’s industrial core is progressing.