USD weakness continues to dominate currency markets; NZ bond and swap curves move closer

By Mike Jones and Kymberly Martin

The NZD/USD ambled sideways for much of the evening with a brief spike above 0.8120, before finishing the night up slightly at around 0.8080.

The backdrop of a broadly weaker USD (which failed to get any lasting boost from the news of Osama bin Laden’s death) and continued strength in commodity prices underpinned the NZD. The CRB index (a global commodity price index) consolidated at elevated levels finishing the night around 368. Yesterday’s release of the ANZ NZ commodity price index told a similar positive story with world prices for NZ’s primary export products rising a further 1.6% in April, to be up 25.4% on year ago. Buoyant global commodity prices, stable risk appetite, and a broadly weaker USD appear to be sufficient to keep the NZD/USD drifting higher despite the RBNZ’s recent statement that NZD strength was ‘unwelcome’.

However the NZD actually drifted lower relative to the EUR overnight as the latter also benefited from USD weakness. The NZD/EUR fell from around 0.5455 to close to 0.5440. The NZD/AUD traded overnight between 0.7365 and 0.7385, ending the night around 0.7370. The RBA meeting today will provide direction for the AUD as the market looks for it to keep rates on hold but leave open the potential for a further 25bp hike over the next year.

We continue to believe that as long as USD sentiment remains in the doldrums, dips in the NZD/USD will be short-lived and there is every chance the NZD/USD will soon eclipse the March 2008 post-float high of 0.8213. None of which changes the fact that the NZD/USD looks overstretched. Recent currency strength has run ahead of domestic ‘fundamentals’ and we look for a modest downward correction over the next few months.

Today we receive the LCI/QES wage report which we believe will show further signs of wage inflation picking up, helping to keep the RBNZ on their toes. In the early hours of tomorrow morning Fonterra’s milk price auction should be fairly stable at elevated levels, demonstrating ongoing resilience in NZ key commodities.

Majors

USD sentiment was briefly boosted on news that Osama bin Laden had been killed but it proved short-lived with the USD index continuing its downtrend, ending the night around 72.880.

The USD fell on the release of the ISM manufacturing index which although slightly above expectation at 60.4 (59.5 expected), is down from the previous month’s reading of 61.20 and appears to show momentum topping out. The prices paid component was also above expectation at 85.5 (83.0 expected).

The EUR was a key beneficiary also boosted by the release of the Eurozone manufacturing PMI that came in at 58.0, above expectation and the previous reading of 57.7. The EUR continued its uptrend rising from around 4.4780 to 1.4860.

As the market discounted any long-term positive effects from the bin Laden news, the VIX index (a proxy for risk aversion) actually ticked higher from below 15 to close to 16. Oil fell slightly, but WTI is still trading over US$113. Equity markets initially crept higher but faded in the early hours of this morning with the Euro Stoxx 50 and the S&P500 both almost flat.

The GBP had a very choppy night but finished the night around 1.6680 close to where it had started. The AUD drifted upward in the backdrop of USD weakness, spiking above 1.100 in the early hours, before ending the night around 1.0960. The RBA meets today. While it is expected to keep rates at 4.75%, any comments will be important as the market continues to look for another 25bp of rate hikes over the next 12 months.
 
Fixed Interest Markets

The NZ bond curve inched lower while swap yields rose slightly from last week’s lows, resulting in a narrower, less negative, EFP (exchange for physical or swaps spread).

10 year swap yields have bounced slightly off last week’s lows to around 5.37% with 2 year yields also up a fraction to around 3.38%, with the shape of the curve remaining relatively stable. NZ government bond yields crawled lower with 19s down over 3bps and 21s down around 2bp. With swaps and bonds creeping in different directions the spread between 10 year swaps and similar dated bonds (EFP) has narrowed further to -5bp. This sees the EFP moving toward positive territory for the first time since late last year.

Off-shore, US 10 year bonds continue to trade around 3.28% with US 2 year yields around 0.6%.  While there have been no new developments in the European sovereign debt crisis, Greek 5 year bonds continue to trade around 16.4% with Ireland and Portugal’s around 11%, suggesting markets continue to assign a high risk premium to investing in these sovereign markets.

Today’s LCI/QES wage report will show whether signs of wage inflation are beginning to creep up, as we expect. Also look out for a potential NZDMO announcement on issuance for the next couple of weeks.

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

All its research is available here.