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NZ Morning Focus

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Fuseworks Media
Fuseworks Media

HIGHLIGHTS

- The PBoC embarked on a major reform of the RMB, undertaking a one-off devaluation and changing the way the fix is set.

- The PBoC changes sparked a classic risk-off move amid economic growth challenges for China. Commodities declined; the NZD and AUD underperformed, equities declined especially those companies with more exposure to China and US Treasuries rallied sharply and the curve flattened.

OUTLOOK UPCOMING TODAY: No local specific data today. In Australia there is consumer confidence (Aug), wages (Q2) and credit card data (June).

CURRENCY: NZD direction now depends on the path of the RMB, with markets questioning if the 'one-off' devaluation will extend. Chinese July economic releases will be closely watched.

RATES: Local yields are expected to open lower given overnight moves.

REVIEW

CURRENCY: China devalued the RMB, sending ripples through currency markets. AUD and NZD were sold on economic concerns, while USD was bid against Asian currencies, but was relatively stable against EUR, GBP, and JPY.

GLOBAL MARKETS OVERVIEW: The PBoC reform of the RMB echoed through the London session. Commodity currencies underperformed following the announcement, but initial weakness was extended on renewed oil price weakness. In contrast, EUR/USD was buoyed after Greece secured a bailout agreement with its creditors. US Treasuries rallied sharply and the curve flattened, with 10-year yields declining 8.8bps to 2.14%. Overall, the recent flattening in the curve suggests that markets are becoming more comfortable with the prospect that Fed policy tightening is likely to be a gradual process, with the pace of tightening potentially limited by USD strength, soft inflation and subdued wage growth. Equity markets were softer across the board, but especially so for companies with more exposure to China. Yesterday's rise in oil prices was short lived with a recovery in Iranian oil production lifting OPEC's output to the highest level in three years. Gold and base metal prices gained marginally.

ANZ'S ASSESSMENT FINANCIAL LIBERALISATION, OR SOMETHING ELSE? The RMB reform can partly be seen as a measure to strengthen the case for its inclusion in the IMF's reserve currency basket (SDR) later in the year. By changing the way the central parity rate (i.e. the fix) is set, from one that is determined by the authorities to one that is more closely based on the onshore spot rate, it ensures that the new fixing better reflects market realities. But the other more important near-term reason for bringing forward these changes is to help ease financial conditions, in light of the weakness in the export sector, which slumped 8.3% y/y in July. While the PBoC says that 1.9% depreciation (the largest change in nearly 20 years) is a one-off adjustment, the big question is how far the authorities will tolerate further RMB depreciation. We note that the PBoC statement mentions the need for some time for the market to adapt to the change, so we suspect the PBoC will ensure markets do not get too carried away. But there is a fine balancing act for the authorities to manage, to ensure that depreciation expectations do not become entrenched, which will lead to a pick-up in capital outflows and further RMB depreciation. So surely, but slowly these structural changes in China's financial liberalisation have clear implications for New Zealand's financial variables, asset prices and demand for our exports and tourism sectors.

OVERNIGHT SPECIFICS AND KEY EVENTS

- US: The NFIB small business survey rose to 95.4 (mkt: 95.4) in July from 94.1 in June. The labour market components improved, with the hiring plans index and the percentage of firms with hard-to-fill job openings both increasing. The labour compensation index also notched to a solid rise to +23 from +21. Overall, these data gel with other indicators of the labour market, such as jobless claims and the ISM survey employment components, which suggests employment growth is likely to remain robust in the coming months.

- Non-farm productivity rebounded in the second quarter. However, the 1.3% y/y gain only just reversed the 1.1% decline in the first quarter. The more worrying aspect is trend productivity remains poor. Productivity growth is the main driver of gains in real wages. Over the past 10 years, real compensation per employee hour has increased by an annual average of only 0.6%. In the 10 years before that the average annualised gain was 2.3%. Real income would be substantially higher without the downtrend in productivity growth.

- Euro area: Greece secured an agreement with its creditors on detailed terms of a third bailout package worth an estimated EUR86bn. The package will run for three years and will require significant fiscal and structural reforms. However, given the economic deterioration in Greece, fiscal targets for the Greek government have been revised sharply lower. The agreement will provide national parliaments with time to approve the package before Greece's August 20 payment to the ECB falls due.

- Equities were a sea of red across the board overnight. The major US bourses fell 1.1-1.5%, with energy and material stocks underperforming. German stocks were hardest hit in Europe declining 2.7% on concerns that China's currency devaluation will erode earnings of companies exposed to the Chinese economy. The Euro Stoxx finished 1.9% lower.

- In bond markets, US and core euro area sovereign bonds rallied. US Treasuries rallied sharply and the curve flattened, with 10-year yields declining 9bps to 2.13% at the time of writing. In Europe German (-7bps), UK (-10bps) and French (-7bps) 10-year yields closed lower.

- Commodities declined with the CRB index back 1.6%. Yesterday's rise in oil prices was short lived, with Crude and Brent oil prices declining a sharp 3.9% and 2.8% respectively. A recovery in Iranian oil production lifted OPEC's output to the highest level in three years. Gold prices gained marginally and base metal prices also finished higher. Grain prices were weaker. For week ending August 9, 70% of the corn crop was rated in good or excellent condition. Last year for the comparable week, 73% of the corn crop was in good/excellent condition (which produced record yields), while the long term average is somewhere in the 60% range. There are still a wide range of opinions as to crop yield potential, and plenty can still change between now and harvest at end of October, but for now the crop appears to be heading for a fairly solid growing season. Weak grain prices provide a lower cost of production for competitors and competing products.

NZD/USD: CHINA LOWERS...

The Chinese undertook major RMB reform yesterday, devaluing the RMB and changing the fixing methodology to one more consistent with a freely floating currency. The onshore drop was around 1.9%, but the offshore currency devalued close to 3%. Markets sold NZD on the view that the devaluation reflects a weaker Chinese economy and reduces Chinese purchasing power. The path of the RMB is now vital for the NZD. Tonight we have the Chinese July data, where markets are expecting stabilisation in economic activity.

Expected range: 0.6460 - 0.6580

NZD/AUD: DEPUTY GOVERNOR LOWE...

Yesterday's Australian business confidence reading declined, and the AUD bore the brunt of the Chinese news. China will again dominate direction, but we also watch a speech by Deputy Governor Lowe.

Expected range: 0.8920 - 0.9020

NZD/EUR: A NEW CYCLE LOW...

NZD/EUR hit a new cycle low as EUR remained in demand while NZD dropped in reaction to Chinese news. Greece appears close to a bailout and despite the German ZEW outlook underperforming, the EU ZEW outlook was strong.

Expected range: 0.5880 - 0.6080

NZD/JPY: LOW PRIORITY...

USD/JPY remains stable meaning this cross remains in-thrall to NZD/USD.

Expected range: 81.00 - 82.10

NZD/GBP: LOWERING UNEMPLOYMENT...

The unemployment report could be GBP positive, as expectations are for a slowing rate of wage growth, leaving room for positive surprises.

Expected range: 0.4130 - 0.4220

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