NZ$ slightly weaker on back of "dovish" OCR statement and falls in interest rate differentials

By Mike Jones and Kymberly Martin

The NZD has been the weakest performing currency over the past 24 hours. Despite the positive impetus from a broadly weaker USD, the NZD/USD dribbled back towards 0.8000 overnight. Yesterday’s RBNZ decision to keep the OCR unchanged at 2.5% surprised no one and the same can be said of the cautious tone in the accompanying commentary.

Clearly the Bank is going to need some convincing the earthquake isn’t going to derail the wider economic recovery and that core inflation is a real threat. This is unlikely to be in evidence anytime soon and so we’re sticking with our view the next 25bps OCR hike will come in December.

Perhaps the most eye-catching part of the Statement was Governor Bollard’s assertion that the high NZD is “unwelcome”. To us, this appeared completely at odds with Bollard’s suggestion only a fortnight ago that the high terms of trade justifies the strength of the NZ dollar. Would the Bank’s true attitude toward the exchange rate please stand up?

In any case, the rhetoric had the desired effect with the NZD/USD sliding around ½ cent in the wake of the statement. And, after a brief bounce to 0.8080, selling pressure returned to the NZD overnight. Most notably, a modest decline in NZ-AU interest rate differentials took a toll on NZD/AUD. From above 0.7420 this time yesterday, NZD/AUD skidded around ¾ cent lower to move into our short-term valuation model’s estimated “fair-value” range of 0.7200-0.7400. Looking ahead, we suspect strongly negative NZ-AU interest rate differentials will limit rallies in the cross to around 0.7450 over the next few weeks.

For today, monthly merchandise trade figures and an update on private sector credit growth will wrap up the local data week. Neither should have any lasting influence on the NZD, which remains captive to USD sentiment for now. In the short-term, NZD/USD support is seen on dips towards 0.7950, with headwinds expected towards the week’s high of 0.8105.

Majors

Most of the major currencies have strengthened against the USD over the past 24 hours, the only exceptions being the CAD and the NZD. As we flagged yesterday, USD sentiment continued to deteriorate in the wake of the FOMC meeting. The Fed’s renewed pledge to keep accommodative monetary policy in place for an “extended period” has seen interest rate differentials continue to move against the USD. For example, EU-US 2-year swap differentials widened to above 155bps – the highest since September 2008.

Last night’s batch of downbeat US economic data didn’t do the USD any favours. March quarter GDP disappointed expectations, slowing to a 1.8% (annualised) pace (2.0% expected). Meanwhile, weekly US jobless claims jumped to 429k, noticeably higher than the 395k expected.

Buoyant risk appetite also continues to take a toll on the “safe-haven” allure of the USD. Overnight, equity markets remained in good heart, thanks to a slew of mostly better than expected corporate earnings reports. European equities rallied 0.9-1.2% while the S&P500 is up around 0.5% at a fresh post-GFC high.

Nevertheless, despite the preponderance of negatives, the USD managed a small bounce later in the night, perhaps a sign the downtrend is starting to become exhaustive. From 1.4880, the EUR/USD eased back to around 1.4820, GBP/USD shed around a cent to 1.6640 (helped by lacklustre UK consumer confidence figures) and the AUD/USD slipped from 29-year highs above 1.0940 to closer to 1.0900.

Fixed Interest Markets

NZ interest rates moved lower across the curve yesterday after the RBNZ left rates at 2.5%, as expected, accompanied by a relatively dovish statement. Swap rates moved lower, with 2 year yields down around 4bp to 3.33% and 10 year yields down around 9bp to 5.38%, resulting in a slight flattening of the curve.

The bond curve moved down by about 5bp across the board. The spread (EFP) between 10 year swaps and bonds has become slightly more negative at around -19bp. The DMO has announced $400m of 19s for its auction today. Given recent demand and the limited amount on offer this week, we would expect the auction to go well.

US 10 year bond yields slipped lower with some volatility overnight from around 3.36% to 3.32%, after a disappointing Q1 GDP number. While economic data continues to be mixed out of the US, corporate earnings remain strong. With the Q1 S&P500 earnings reporting season now more than half way through, close to 80% of companies have surprised positively with y/y earnings growth sitting around 21%.

In Europe Portugal remains in negotiations regarding its bailout package. Portuguese 5 year CDS spreads have narrowed a fraction though remain elevated at 654bp. Portuguese 5 year bond yields remain at 11.4% close to Ireland’s at 11.2%, but someway below Greece’s at 16.4%.

There will be little to drive NZ interest rates today, though keep an eye on the results from the DMO auction.

Mike Jones and Kymberly Martin are part of the BNZ research team. 

All its research is available here.