Euro fear takes hold; NZ$ and A$ fall as the herd flees to safety in US$ and Yen

By Mike Jones and Kymberly Martin

The NZD has started the week on the back foot. From about 0.7950 this time yesterday, the NZD/USD has shed around ½ cent over the past 24 hours.

Last night’s currency movements were all about risk aversion, as the European sovereign debt crisis took another turn for the worse. Nascent evidence of contagion from Greece to other indebted European sovereigns saw global equity markets plunge, commodity prices fall and “safe-haven” currencies like the USD and JPY outperform. Our risk appetite index (which has a scale of 0-100%) skidded from 72% to 67.1%.

While the NZD suffered from this general “risk-off” sentiment, a much heavier toll was taken on the AUD. The AUD/USD tumbled 1½ cents to nearly 1.0500 amid heavy real money and custodial selling. At the same time, a squaring up of short NZD/AUD positions by macro and leveraged players provided an additional boost for the cross. From 0.7460, the NZD/AUD climbed steadily to around above 0.7520, limiting last night’s dip in the NZD/USD to around 0.7870.

Today’s Q2 RBNZ inflation expectations survey marks the only macro-economic report of note to be released this week. We’re expecting the 2-year ahead measure to hold around the 2.6% mark. While not exactly pressing in the context of the 1.0 to 3.0% range, neither does it allow much headroom going forward, into the GDP and core-CPI upswing we’re seeing as more and more likely.

We’ve been highlighting the fact the global backdrop has become a less friendly place for the NZD/USD of late. As uncertainty about the impact of Greece’s debt woes continues to percolate, “growth-sensitive” currencies like the NZD/USD look set to continue to struggle.

In the short-term, the NZD/USD looks fairly well entrenched in the familiar 0.7750-0.8000 range. We suspect the currency will spend most of this week trading choppily inside this range.

Majors

The USD and JPY were the strongest performing currencies overnight as creeping risk aversion spurred demand for “safe-haven” assets.

Fears Greece’s sovereign debt crisis is spreading took a toll on investors’ risk appetite. Hot on the heels on yesterday’s three notch Greek downgrade, ratings agency Fitch revised the outlook on Belgium’s AA+ sovereign rating to negative from stable.

European sovereign credit spreads continued to widen, a worrying sign of Greek contagion in the eyes of some. The spread between 10-year Portuguese government bonds and German bunds jumped 30bps to 660bps, while the Spanish equivalent rose 10bps to 250bps.

Mounting worries about the health of the Eurozone saw European equity markets notch up losses of 1.9-2.1% while the US S&P500 is down 1.2%. The VIX index (a proxy for risk aversion) leapt from 17% to almost 20%. Commodity prices also suffered, in part thanks to yesterday’s signs of slowing in Chinese manufacturing (the HSBC PMI fell to 51.1 in May from 51.8 in April). The WTI oil price slipped 2.5% to US$97.60/barrel and the broader CRB commodity price index is down around 1.4%.

Against a backdrop of rising risk aversion and equity market weakness, investors scrambled back into “safe-haven” currencies like the USD and JPY at the expense of currencies like the EUR, AUD and GBP.
Weaker-than-expected European data compounded the EUR’s woes. The European composite PMI eased back to 54.8 in May, noticeably below the 57.5 expected. From around 1.4150, the EUR/USD briefly skidded to 2-month lows below 1.4000. The fallout on the GBP was more limited, thanks to some hawkish Bank of England rhetoric. Chief economist Dale said the BoE needs to raises rates to stave off damaging inflationary forces. GBP/USD fell from 1.6200 to closer to 1.6100.

Looking ahead, there are a few important economic data releases to keep an eye on this week. US Q1 GDP figures on Thursday, the second estimate of Q1 UK GDP on Wednesday and tonight’s German GDP and IFO confidence figures are all worth watching. However, it may be that official rhetoric is just as important for dictating currency market sentiment. Unless European policy managers can soothe investor worries about Greek contagion we’d expect downward pressure to remain on the EUR/USD. Having broken 1.4045, traders will be eyeing up 1.3850 as the next layer of support.

Fixed Interest Markets

Bond and swap markets rallied as global risk aversion ticked up on heightened concerns regarding Greece’s debt situation.

Off-shore developments are the key driver of NZ interest rate markets at present. All attention is focused on Greece and discussion of various unpalatable options to “resolve” its debt problems. German bond 10-year yields fell to as low as 3%, while Eurozone peripheral yields rose, widening their spreads to bunds. Greece’s 10-year bond yield reached a new high of 17%. Irish, Portuguese and Spanish yields also rose sharply raising concerns of contagion in the region.  In response, the Greek cabinet has endorsed a further package of spending cuts and state asset sales.

As risk aversion has ticked up and equities have experienced another weak night, US “safe haven” 10-year yields have also inched lower. At one point they traded as low as 3.09% before returning to familiar levels around 3.13%.

NZ bond yields have crept lower with 21s now trading as low as 5.10%, the lowest level since late October last year, soon after they bottomed around 5.00%. The yield on 13s also traded down to around 3.10%.
Swap markets also saw a decline in yields, falling around 5bp at the long end, and 3-4bp for 2-5year swap yields. With the 10-year swap rate now around 5.18% and the 2-year at 3.3%, the 2s-10s curve has flattened to around 188bp.

See our interactive swap rates charts here and bond rate charts here.

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

All its research is available here.