S&P downgrade of US debt outlook to negative from stable 'doesn't appear to have had a lasting affect on bond markets'

By Kymberly Martin

With risk appetite showing a modest rebound (our risk appetite index climbed from 69% to 72%) the NZD was relatively stable overnight versus a weaker USD, trading around 0.7880. Equities made modest gains, with the Euro Stoxx 50 up 0.3% and the S&P500 up around 0.5%, the CRB commodity index ticked up to 361 and the WTI oil rose around 1% to US$108.

The NZD lost ground relative to a broadly stronger EUR (that was underpinned by a positive surprise on the Eurozone PMI), subsiding from around 0.5520 to 0.5490. Relative to the GBP the NZD was relatively range-bound ending the night around 0.4830.

Yesterday’s RBA minutes provided little surprise for markets, although confirming that inflation remains firmly on the RBA’s radar. The NZD consolidated relative to the AUD ending the night around 0.7490, after a bit of intra-night volatility. We continue to expect the NZD/USD will struggle to make significant upside progress this week, given its recent run-up has taken it well above fundamental “fair-value”.

In the short-term, we continue to eye support on NZD/USD towards 0.7820. There is no NZ data of significance today, although ahead of the Easter break, we receive NZ credit card spending and ANZ-RM consumer confidence data tomorrow, along with the US leading indicator and Philadelphia Fed that will provide indications of how the US recovery is developing.

Majors

The USD index was a little weaker overnight, falling to around 75.00, giving back some of its rally of the last few days, though holding above recent lows. The key beneficiary of USD weakness was the EUR rising from around 1.4220 to 1.4340. Despite ongoing Eurozone sovereign debt issues the common currency rose in the backdrop of a positive surprise on PMI data. The Eurozone composite PMI rose to 57.8 in April (57.0 expected) with both manufacturing and services remaining solid.

Markets continue to price close to 90bp of further tightening from the ECB over the next 12 months. The GBP also inched higher from around 1.6260 to 1.6320 ahead of today’s Bank of England minutes that will shed some light on how their debate is developing, in an economy that shows clear inflationary pressures but is still experiencing a relatively weak consumer sector.

The BoE is widely expected to be the next major central bank to raise rates, later this year, ahead of any move by the Fed. The JPY range-bound ending the night around the level it started at 82.40.

Yesterday’s RBA minutes showed that global inflation is well and truly on their radar, and that despite risks to global growth they expect prices for Australia’s main exports to remain high “for some time”. The market continues to price a further rate hike by the RBA at some point over the next 12 months. The AUD traded slightly higher against the weaker USD to around 1.0520, just below recent 29 year highs of close to 1.0580.

Fixed Interest Markets

US 10 year Treasury yields fell overnight to around 3.35%, back into familiar territory where they range-traded throughout December and January. The move on Monday by rating agency S&P to downgrade the US AAA sovereign debt outlook to “negative’ from “stable”, for the first time in its 70 year history, does not appear to have had a lasting affect on bond markets.

The S&P move is widely seen as a political act to increase the chance of a long-term debt deal, given current negotiations in Washington, although theoretically pointing to an increased default risk on US government bonds. More urgently, debt concerns continue to lurk in the Eurozone, where Greece, Portugal and Ireland now all have 5 year government bond yields at 10% or above.

Credit Default Swap spreads also sit between 600bp to 1330bp reflecting market’s heightened concern of default. In similar moves seen in US bonds over the past week NZ 10 year bond yields declined further to around 5.69%. NZ swaps have rallied further with 2 year yields now back at 3.34%, at levels seen prior to Bollard’s comments on inflation last week that had seen a meaningful rise in yields.

Ten year swaps have also rallied, although not as strongly, with yields back at 5.43%. As a result the curve is now somewhat steeper than a week ago, with 2-10yr spread now at around 210bp. A quiet day ahead will likely see range-bound yields although look to NZ credit card spending and ANZ-RM consumer confidence data tomorrow. Indications of consumer resilience post the Christchurch earthquake could arrest the recent NZ interest rate rally.

Kymberly Martin is part of the BNZ research team. 

All its research is available here.