They say that “a week is a long time in politics” – it is an even shorter time in the wonderful world of bond and interest rate markets.
A week ago the US 10-year Treasury Bonds were trading at a market yield of 2.85% with a general “flight to quality” from global investors ahead of the Greek parliamentary vote. Seven days later the direction and mood of the bond market has shifted on from Greece and is starting to focus on the fact that QE2 has ended and the US Fed Reserve are not the big buyers of bonds anymore. As a consequence, the unwinding of pre-Greece market hedging has seen yields shoot back up to 3.18%.
Our 10-year swaps have followed the US and have jagged back up to 5.18% from 5.00% over the same period. The shorter-term swap rates are up 10 basis points on last week’s lows as the moneymarkets realised that the previous low pricing was becoming out of whack with reality. Recent releases of economic data in New Zealand all point to stronger activity levels than generally expected, thus I would view that the inflation risks for 2012 have increased further. Capacity utilisation numbers out tomorrow with the NZIER Quarterly Survey of Business confidence results should provide another signal to the RBNZ that inflationary pressures are gathering i.e. capacity utilisation up from the current 89.4% level.
GDP growth data on Thursday is also more likely to surprise on the top-side and cause a few revisions of 2011 annual GDP growth forecasts. By the time we get to the June quarter’s CPI inflation figures due for release in two weeks time, the short-term swap rates could be another 10-15 basis points higher again. Baring another major earthquake jolt in Christchurch, it looks like the one to three year swap rates have completed their double-dip lows (March 2009 and March 2011). The five to ten year swap rates have had three dips to the March 2009 lows over the past 12 months. However given the likely increase in US 10-year Treasury Bond yields up to 3.50% over coming months, there has to be a lot of confidence that the longer term swap rates are only heading one way from current levels i.e. upwards.
One market influence that might restrict the immediate upward direction of our two to ten year swap rates is what is going on in the Australian economy. Rightly or wrongly changes in Australian market interest rates impact directly on our market here. Over recent weeks it appears that some luck has finally run out for the lucky country (unless your name is Quade Cooper of the Queensland Reds – however his luck will terminate next Saturday when Richie and Kieran line him up!). Today’s economic announcement in Australia of lower job adverts, lower housing starts and lower retail sales are symptomatic of a slew of data over this past month which has all been weaker than expected. The Reserve Bank of Australia will certainly not be delivering a hawkish-toned monetary statement tomorrow. The rising NZD/AUD cross-rate from 0.7400 to 0.7750 tells us that the FX markets are already pricing-in NZ interest rates moving up to match Aussie interest rates over the next 12 months.
Borrowers contemplating fixing more debt should not be complacent about the market risks ahead of them i.e. act sooner rather than later. Investors who have been investing short awaiting higher market rates will eventually be rewarded for their patience. The earthquakes have only delayed the inevitable by six months, but now the future is clearer for both borrowers and investors. Their respective decisions and actions over coming months will make the forecast of sharply rising interest rates a foregone conclusion and self-fulfilling prophecy.
NEW ZEALAND DOLLAR MARKET COMMENTARY
The positives and the negatives from a 0.8300 Kiwi dollar
The NZD/USD exchange rate has returned to near its 0.8300 highs following the “relief rally” in global financial and investment markets after the Greek Government voted in their economic austerity package.
Prior to the Greek climax last week, the Kiwi had weakened back to between 0.8000 and 0.8100 due to lower commodity prices and a lower AUD rates against the USD. In voting in the spending cuts, tax increases and state asset sales, the Greeks averted defaulting on their debt and the financial markets hurriedly bought back what they had sold/hedged beforehand. Certainly a failure by the Greeks to pass the austerity measures would have seen a massive sell-off in the Euro exchange rate against the USD and with that a lower NZD value. For the meantime “risk is back on” in the international investment markets and the NZD tends to appreciate when global sharemarkets move upwards.
Commodity prices, as measured by the CRB Index, however have not returned to their upwards path following the Greek vote. Weaker US and Chinese economic data, coupled with the formal ending of US quantitative monetary easing (QE2) has lowered global GDP growth forecasts over recent weeks and the gung-ho confidence of buying commodity prices higher has dissipated. The feeling in international commodity markets is that the favourable winds pushing prices higher over the March 2010 to March 2011 period have turned somewhat, particularly as higher food and energy prices hurt consumer spending around the world and threatened the global economic recovery.
The investors and speculators in commodities are now re-assessing their “long” strategies and market positioning. The Australian dollar was trading below $1.0500 against the USD prior to the Greek vote. It has bounced back up again to $1.0780, however further weakness in the CRB Commodity Index should prevent any further AUD gains.
Looking ahead over coming weeks, the following economic and market developments stand out as being potentially positive or negative for the NZD/USD exchange rate from current elevated levels:-
Positive
§ New Zealand GDP figures on Thursday 7 July for the March quarter may well prove to be more positive than what the markets expect. Improvements in retail, export and manufacturing sectors may produce a quarterly increase of up to +0.5%, whereas not so long ago market economists were forecasting a negative number.
§ The NZIER quarterly survey of business opinion on Tuesday 5th July should confirm the stronger business outlook seen in the monthly surveys. Higher export prices are certainly lifting production and investment in the New Zealand economy. True to form, the NZIER economists will endeavour to put a gloomy spin on likely positive survey results!
§ The European Central Bank review their official interest rates on Thursday 7 July and another increase will be positive for the Euro currency and thus send the Kiwi up through the previous 0.8320 highs. A no increase decision by the ECB with tough talk on controlling inflation would be neutral for the EUR and NZD, as it is no change to the current position.
§ The NZD is no longer matching the gains on Wall Street like it was a few months ago, however the stronger US manufacturing ISM Index released last Friday (up from +53 to +55) does suggest that the weak patch in US economic data could be coming to an end. The Federal Reserve’s view that the weaker data over recent months was only temporary could be further confirmed by stronger employment figures this Friday 8th July. The stronger US economic picture would be positive for the Dow Jones Index.
Negative
§ The Reserve Bank of Australia is not expected to change their official interest rates when they meet on Tuesday 5th July. A more dovish than expected statement could be on the cards as the RBA recognises that weaker domestic economic data (outside the mining states) has arguably lowered future inflation risks. International economic commentators still fret that Australia’s house price bubble has never deflated during or after the GFC. There is no question that higher mortgage interest rates is hurting demand and spending in the mortgage belts in Sydney and Melbourne. The Aussie money markets are pricing for no change in interest rates. Further reductions in residential property prices in Australia will not be positive for the AUD.
§ Outside the normal international influences, the one variable that could cause the Kiwi dollar to drop on its own is Wholemilk Powder (WMP) prices. Fonterra are not expecting a major correction down in WMP prices from the current lofty levels that they have risen to. However, buyer resistance and substitution of WMP is causing some nervousness about the sustainability of the super high prices. The Global Dairy Trade auctions this week may see lower prices as the latest market uneasiness permeates through.
§ Global FX markets may now start to focus on the US ending the printing of additional US dollars with the cessation of QE2, now the Greek crisis is avoided (for the meantime!). Looking ahead, US short-term interest rates eventually returning to normal levels around 3% should be positive for the USD across the board. A break below $1.4000 in the EUR/USD rate on more positive USD sentiment is the one factor that can return the NZD/USD rate to the mid 0.7000’s over coming months.
How the aforementioned positive and negative forces play out will determine whether the NZD can hold onto the recent gains to the record high of 0.8300.