Milk price and inflation expectations boost NZ$. NZ$ interest rates imply 25bp Dec hike

By Mike Jones and Kymberly Martin

The NZD has been the strongest performing currency over the past 24 hours. From around 0.7900 this time yesterday, a trifecta of currency positives launched the NZD/USD back up to around 0.8000 overnight.

First up, dairy giant Fonterra yesterday announced not only a higher payout for the coming season (of $8 to $8.10) but a very solid payout forecast range of $7.15 to $7.25 for the 2011-12 milk season. Both compare very favourably to the 10-year average payout of $5.42 and the 5-year average of $6.46. See more here from Bernard Hickey on Fonterra's payout.

Second, local interest rates and RBNZ cash rate expectations were jolted higher by yesterday’s news inflation expectations are hitting 20-year highs. The closely watched 2-year ahead annual-CPI inflation expectations measure spiked to 3.0%, from 2.6%. It’s a big wake up call for the RBNZ, something that wasn’t lost on the market. Implied OIS market pricing of RBNZ rate hikes rose from 46bps over the next year to 52bps and the NZD/USD jumped ½ cent to around 0.7970.

Overnight a broad-based weakening in the USD provided a boost to all of the major currencies. Not only did dovish rhetoric from the US Federal Reserve weigh on the USD, but the EUR/USD bounced back on easing Greek default concerns. Against the broadly weaker USD the NZD was dragged up to an overnight high of nearly 0.8020. However a bout of real money NZD/AUD selling late in night means the NZD/USD opens this morning back below the 0.8000 level.

Looking ahead, the failure of the NZD/USD to sustain last night’s break above 0.8000 means the currency should settle back into our favoured 0.7750-0.8000 range for rest of this week. There is no local data to watch out today for but keep an eye on the news wires. Both Prime Minister Key and Finance Minister English are due to speak during the day.

Majors

The USD lost ground against all of the major currencies overnight. Not only did a stabilisation in risk appetite temper demand for “safe-haven” currencies like the USD, but dovish Fed rhetoric also weighed.

St Louis Fed President Bullard (a non-voter) said “prolonged financial market turmoil could be a negative for the US" while Fed Governor Duke highlighted the negative impact of high oil prices on the US economy. US bond yields were dragged lower in response, providing mild headwinds for the USD.

The EUR climbed steadily for most of the night, albeit with conflicting data and rhetoric keeping trading whippy. Early in the night the stronger-than-expected German IFO index (114.2 vs. 113.7 expected) provided some legs for the single currency. However reports the Greek opposition had rejected the government’s austerity plan soon cooled some of the EUR enthusiasm. The EUR/USD finished the night up around 1 cent at 1.4100.

Ratings agency Moody’s yesterday warned up to 14 UK financial institutions could receive a ratings downgrade, reflecting the eventual withdrawal of UK government support. The knee-jerk reaction saw GBP/USD dip ½ cent to around 1.6060. However the broadly weaker USD allowed to GBP/USD to later shake off its early losses to finish the night just under 1.6200.

Disappointing UK April public borrowing figures were all but shrugged off by the GBP. The figures revealed a whopping £10b UK government deficit (£6b expected) – the worst April deficit on record.

Looking ahead, tonight’s second release of Q1 UK GDP should confirm the 0.5%q/q growth rate indicated by the first estimate. Anything less could see the GBP/USD re-test support around 1.6060. Also keep an eye out for April US durable goods orders.

Fixed Interest Markets

After a quiet start to the day interest rate markets kicked into action yesterday following the release of the RBNZ inflation expectations survey.

The scarily high inflation expectations figures (3.0% for 2-year ahead and 3.1% for 1-year ahead) saw solid payside interest in the swaps market push the 2-year swap rate up 6bps to nearly 3.35% – essentially reversing the grind lower over the last few sessions.

It’s worth noting that at current levels, the 2-year swap seems to be pricing in a 25bps hike from the RBNZ in December with a series of hikes thereafter taking the OCR to 4%. This is close enough to our own view of RBNZ policy such that current pricing is close enough to “fair” in our view. Nonetheless we continue to caution that the risks appear tilted in favour of a faster and more aggressive RBNZ tightening cycle. Yesterday’s inflation expectations figures served only to reinforce this view.  

For today, expect local swap yields to open unchanged to slightly lower. There wasn’t a lot of direction from overnight offshore moves – US Treasury yields ended the night 1-2bps lower. However we may see offshore names use yesterday’s mild sell-off in swaps to enter fresh received positions with the worsening Greek debt situation still dominating offshore credit market sentiment.

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.