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BNZ Daily Markets Wrap and Strategy

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Fuseworks Media
Fuseworks Media

NZD

The NZD lost ground amidst a backdrop of USD strength on Friday, with NZD/USD weakening by 0.4% to 0.8610. The picture was decidedly more mixed on the crosses, however, with slight gains seen against the EUR and the GBP.

Despite the backward step for the USD on Friday (see Majors), we think the underlying story of low US bond yields and low currency volatility remain supportive of the carry trade. Note that 3-month implied volatility for NZD/USD collapsed on Friday to 8.05%, the lowest since December 2012.

This week sees the annual Budget officially released, as well as the RBNZ’s semi-annual Financial Stability Report. The themes from both these centerpiece documents have already been well signaled. The Budget will show a return to surplus in 2014/15, and the FSR is set to highlight risks in farm debt and conclude that LVR restrictions have proven effective. Neither should provoke much of a response within currency markets.

Given the dearth of local data today, it looks to be a sleepy start to the week for currencies. This morning, we eye initial support at 0.8590, ahead of the fairly robust 0.8500 figure. Spurts higher toward 0.8670 should be challenged.

Majors

After the fireworks following Yellen and Draghi on Thursday night, markets were fairly quiet heading into the weekend. A strengthening USD was the dominant theme in the currency space.

The USD gained against all the majors, especially against the EUR and the CAD. EUR/USD lost 0.6% to fall to 1.3760, extending its post-ECB decline. This takes the single currency to levels last seen in early April, after coming tantalisingly close to breaking above 1.40. Widespread expectations of an ECB rate cut in June should keep the EUR subdued in the short term.

The CAD jerked lower against the USD after Canada’s April employment report came in much weaker than expected. A 28.9k fall in employment reversed over half of the 42.9k gain seen over March, shocking a market looking for a modest (+12k) rise. The CAD dropped by 0.6% against the USD, to 1.09.

The broad USD strength saw the US Dollar Index climb 0.6%, to 79.90, its chunkiest single-day gain since the Fed’s unintentionally hawkish March meeting. ECB President Draghi’s swing at the EUR has helped to stem the USD’s inexorable decline, for now.

This week, events out of the US will hold our attention the most. On the data front, retail sales and inflation numbers will be the highlights, and (amongst other Fed speakers) Fed Chair Yellen’s address to the US Chamber of Commerce will be closely parsed, despite her newfound ability to avoid direct answers. Across the Atlantic, the advance reading for Euro-zone GDP (Thu) and the Bank of England’s quarterly Inflation Report (Wed) will be key determinants for the EUR and GBP respectively.

Closer to home, China sees its monthly dump of investment, retail sales, and industrial production data on Tuesday. As important for the AUD will be the Australian Federal Budget (Tue), though much of this has already been pretty comprehensively leaked.

Fixed Interest

NZ swaps closed flat to up 2bps. On Friday night US 10-year yields traded from 2.59% to 2.62%.

NZ 2-year swap closed up 2bps, at 3.96%, while 10-year was largely flat at 4.79%. This saw the 2-10s swap curve flatten to 83bps. In the coming year we expect the curve to continue flattening as short-end yields rise with the OCR. We see a 50bps trough in the 2-10s curve within this period. We continue to expect the OCR will reach 5.00% within the next two years. The market prices that it will only reach around 4.30% over this time frame.

We therefore see ‘value’ in hedging at current 2-4-year swap rates. This is the case even after accounting for the possibility that the high level of the NZ TWI slows the pace of near-term OCR hikes.

Meanwhile, yields on NZ bonds continue to slump. The yield on NZGB23s is now at the lowest level since early last August. Spreads to AU and US equivalents have also fallen to bottom of ranges.

There are several events of interest to the NZ bond market this week. Thursday’s Budget will be accompanied by an announcement by the DMO. There is potential for it to indicate it plans to issue a longer-dated bond, given NZ’s longest bond is now less than nine years. However, overall NZGB issuance projections will remain quite tight as the government remains on track to record a surplus in 2014/2015. Friday’s DMO auction of $200m of nominal bonds will also be closely watched. Finally, Wednesday will bring the latest figures on non-resident holdings of NZ bonds. It will be interesting to see if recent enthusiasm for NZGBs has curtailed the recent downtrend in the proportion of offshore holdings.

It will be a quiet start to the week with nothing scheduled on the domestic data agenda today. There was also not too much direction provided for rates markets offshore on Friday night. Both US Treasuries and Aussie bond futures traded fairly tight ranges.

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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