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BNZ Daily Markets Wrap and Strategy

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Fuseworks Media
Fuseworks Media

NZD

The NZD has rocketed higher on the back of broad-based USD weakness. Its appeal as a carry-trade target currency has it sitting atop the G10 currency leaderboard against the USD. It is up 0.9% to 0.8750, a fresh 2.5-year high.

The weakness of the USD and still-falling currency volatility continues to drive investors into carry trades, which take advantage of interest rate differences between countries (see Majors). By some measures, the NZD has never been more appealing for a carry-trade investor funded out of USD. No wonder, then, that the NZD is looking to threaten 2014-highs against low-yield currencies like the EUR and JPY. Overnight, NZD/EUR strengthened by 0.5% to 0.6280, while NZD/JPY rose by 0.4% to 89.0.

We remain cognisant that USD rallies tend to be accompanied by higher currency volatility. Since that would undermine the NZD/USD from two sides, the eventual correction could well be very sharp.

In this environment, investors ignored the fact that one of the key struts of NZD strength continues to erode. Last night’s Global Dairy Trade auction registered a further 1.1% decline in milk prices, the sixth consecutive decline. In due course, this will weigh on NZ’s terms of trade. But for the moment, yield-hungry investors are turning a blind eye.

It is a busy morning ahead for the NZ market. RBNZ Governor Wheeler is due to speak at 9.30 (NZT) on the importance of dairy to New Zealand to an industry body. Any fresh indication of discomfort about the high currency will put a dampener on the NZD. Note that the NZ TWI hit a fresh post-float high of 81.20 earlier this morning.

Later on, NZ’s Q1 2014 labour market report is expected to show a marginal improvement in the unemployment rate to 5.9, despite an increase in participation.

Majors

The USD is weaker across the board, falling sharply against all the major currencies, and most emerging market currencies to boot. The pervasive disenchantment with the USD continues to gain traction.

The outstanding feature of the past two weeks has been a sheer reluctance of markets to buy into US economic strength. That became abundantly clear when the USD was unable to hold on to strength following last week’s (overall) positive employment report. The view gaining momentum is that the Fed will continue to concentrate on signs of labour market weakness, such as poor wage growth, while downplaying improvements in headline activity data.

The result is that the USD and US interest rates remain subdued, feeding the appetite for carry-trade plays. With the fresh round of USD disenchantment overnight, we are unsurprised that typical carry-trade targets like the AUD, BRL, ZAR, and TRY are amongst the better performers.

Positive economic data helped the EUR and GBP grind higher. The Euro-zone’s composite PMI for April was confirmed at 54.0, but some other components surprised. For example, Spain’s services PMI has basically returned to levels last seen at the height of its last economic boom, circa 2007. In the UK, the service sector PMI beat expectations to hit 58.7, the 16th consecutive month of expansion. The EUR/USD gained 0.4% to 1.3930, while the GBP/USD rallied by 0.7% to 1.6980.

Yesterday, the RBA refrained from introducing any new admonishments about the level of the AUD, inspiring a brief spike higher that was quickly retraced. The Bank left its policy settings unchanged, and appear to be comfortably on hold for some time. Later on, the AUD/USD caught a fresh bid amidst the wave of USD weakness, gaining 0.9% to 0.9360. Its appeal as a carry-trade target helped it onto the one-day currency podium, second only to the NZD.

Tonight, markets will likely take a breather ahead of Fed Chair Yellen’s testimony to the Joint Economic Committee at Congress. It seems unlikely that Ms Yellen would introduce any new themes in her prepared statement, but she may be pushed to comment on the recent improvement in US data. No doubt every comment will be scrutinised carefully.

Fixed Interest

NZ yields closed up 1-2bps in quiet markets yesterday. Overnight, US 10-year yields slipped to 2.59%.

NZ 2-year and 5-year swap closed at 4.00% and 5.00% respectively. We continue to see hedging value at these levels, particularly in 2-4-year rates.

We accept that the near-term pace of RBNZ rate hikes could be slowed by the current elevated level of the NZ TWI. However, we do not see this impacting on the medium-term trajectory for the OCR. We see it reaching 5.0% by the end of next year i.e. a further 200bps of hikes. The market prices only 125bps of hikes by this time.

Yesterday, the RBA left the cash rate at 2.50%, maintaining a neutral bias. It is comfortably on hold, ready to sit back and see how the economy plays out in coming months. The market prices a first 25bps rate hike by around September next year. However, the AU market is likely in a similar phase to that which NZ has just exited. i.e where the cash rate is ‘on hold’ at low levels for a protracted period but market expectations oscillate, providing trading opportunities.

While equity markets were fairly subdued overnight, US 10-year yields rose as high as 2.62%, before falling back to 2.59%. They remain at the bottom of year-to-date ranges. In the early hours of tomorrow morning (NZT) Fed Chair, Yellen, is scheduled to testify to the Joint Economic Committee. However, it is difficult to envisage she will say anything to jolt yields out of their current slump.

Domestically today, the NZ labour market reports will be released. We are looking for a solid 0.6% gain in Q1 employment (3.4%y/y). However, yet another strong data point is unlikely to push short-end NZ yields notably higher, given the level of the NZD. In addition, the long-end of the NZ curve will continue to be mostly beholden to moves in offshore (US, AU) yields.

For other BNZ research, such as the Markets Outlook and the Economy Watch, please go to www.research.bnz.co.nz.

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