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Markets more positive after China policy eases

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Fuseworks Media
Fuseworks Media

The NZD/USD spent most of last week trading choppily in the familiar 0.8270-0.8430 range.

Global risk appetite continued to improve last week.

A surprise Chinese policy easing and the long-awaited announcement of a second Greek bailout package saw investors become more positive on global growth prospects. Global equity markets rallied and our risk appetite index (scale of 0-100%) rose from 61% to end the week around 63%.

These gains in risk appetite helped underpin "risk-sensitive" currencies like the NZD and AUD last week. However, the EUR was the star performer. Investors' relief that Greece may yet avert a disorderly default spurred heavy speculative and real money demand for the EUR and EUR crosses. The NZD/EUR was knocked from above 0.6350 to around 0.6215 as a consequence. The weakening NZD/EUR helped limit NZD/USD gains to the 0.8400/0.8430 region last week.

We still think interest rate and growth fundamentals are skewed in favour of the NZD/EUR. As such, we doubt last week's sell-off represents the beginning of a new downtrend. We forecast NZD/EUR at 0.6350 by June.

It's worth noting, surging global oil prices may also have weighed on the NZD last week. Rising Iranian political tensions have seen prices jump 11% in February to date, to nearly US$110/barrel. Worries that higher oil prices (on supply concerns) could knock the steam out of global growth are a negative for "growth-sensitive" currencies like the NZD. This is an area to watch in coming weeks.

Stepping back from the near-term noise, the NZD/USD has spent February chopping sideways in a 0.8250-0.8430 range. Undoubtedly, short-term "fundamentals" suggest the NZD/USD should be lower. However, solid global risk appetite and a weak USD are keeping the currency elevated. As such, these trends will need to reverse if we are to see the NZD/USD break convincingly below 0.8250.

We doubt we'll see any such trigger this week, so more rangy trading inside 0.8250/0.8430 can be expected. The biggest test of market sentiment will come with Wednesday's ECB long-term refinancing operation (LTRO, see majors). There's also an increase in the NZ data schedule, with Wednesday's NBBO and today's trade balance figures ($NZ339m surplus expected) the highlights.

Majors

The major currencies put in a generally mixed performance on Friday night. The USD index drifted off from 78.80 to around 78.40. The EUR remained in demand for most of the night, providing headwinds for the USD.

Recent EUR gains have come amid a clear easing in fears over contagion from Greece. Greece still has a number of bailout implementation hurdles to cross, but investors are now more confident these can be overcome. On Friday, a jump in German business confidence and the near-passing of the Greek PSI deal kept positive EUR sentiment intact. EUR/JPY surged from 106 to 109, underpinning a climb in EUR/USD from 1.3370, to two-month highs close to 1.3450.

Still, the most eye-catching move was a leap higher in USD/JPY, to nearly 81.00. This was thanks to more positive US economic news (consumer confidence hit one-year highs) and the Fed talking up US growth prospects (courtesy of St Louis president Bullard - a hawk). We look for some stabilisation in USD/JPY after the recent run up - unless global growth dynamics (and hence relative yield spreads) turn even higher.

The weekend's G20 meeting was (yet) another unexciting affair. There were more soothing words about Europe. Encouraging for some, was Germany's apparent softening of their previous view the Eurozone bailout fund doesn't need to be topped up. Speculation is now rife that another huge (circa US$2t) package could be announced at the April G20 meeting.

Looking ahead, the EU summit on March 1 and 2 looks set to be another talk-fest. Big decisions/policy actions will likely be put off until the April meeting. In contrast, Wednesday's second ECB LTRO could have a material effect on markets.

Market expectations are for anywhere from ?400b to ?1t of funding to be requested by banks at the LTRO (?489b was allotted in December). A take-up towards, or above, the upper-end of expectations would likely provide a boost for the EUR and "risk-sensitive" assets. The last, larger-than-expected LTRO, was certainly a big positive for market sentiment.

Near-term resistance on the EUR/USD is eyed on bounces towards December's 1.3550 highs. Support should be found towards 1.3240.

Fixed Interest

NZ swap yields ended the week at new highs since November. Offshore "safe haven" yields remain in ranges.

NZ swap yields, that have been on a strong upward run since the start of the month, pulled back mid last week, before finishing the week at new highs. On Friday, swap yields were up 6bps across the curve, led by a spurt of pay-side interest in the short-end. At one point, 2-year yields traded as high as 3.11%, before closing at 3.09%.

We are starting to see some flows from businesses, keen to hedge balance sheet risk. Next technical resistance for 2-year swap yields is 3.20%. At present, the market prices around 25bs of RBNZ hikes in the year ahead. We expect up to 75bps of hikes in the coming year. We therefore continue to believe the bias is toward higher swap yields, with dips unlikely to revisit old lows. The swap curve remains quite stable just over 140bps.

NZ bond markets were quiet on Friday, though yields ended the week a little higher. The yield on NZGB21s closed around 4.14%, their highest close since early November. Overnight on Friday, "safe haven" US and German 10-year yields continued to languish at 1.98% and 1.88% respectively. Despite notable improvement in US economic data in recent months, this is not being reflected in higher US long yields. They fail to break above 2.10%. This suggests that Fed purchase of US long bonds is being "successful" in keeping yields low.

While this will keep NZ long yields lower than otherwise would be the case, we believe it will not prevent them moving higher. NZ-US 10-year bond yields have moved up to 216bps, convincingly breaking out of previous ranges. We now see resistance at 240bps.

Wednesday's NBNZ business survey will be the key local release this week. This will be the most substantial assessment of the pulse of NZ business this year. We expect results to be consistent with GDP growth running at trend, at least. A strong reading could provide the next leg up for NZ swap yields. The greatest downside risk to yields this week comes from any negative developments in Europe, which would cause the market to revise down expectations for RBNZ rate hikes in the year ahead.

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