NZD outperforms

NZD has been the best performing major currency so far this year outshining other currencies by a wide margin. We expect further NZD/USD appreciation, albeit at a much more gradual pace over the coming months.

The kiwi has been propelled higher by a host of positive economic indicators including jobs data which has revealed an improving trend against the background of strengthening consumer and business confidence.

Economic growth is on track to reach our forecast of 3% this year. Additionally supportive of the NZD is the fact that NZ’s major commodity exports especially dairy products have remained high. NZD will also be helped by a likely healthy reading for Q4 GDP expected to come in at 3.7% YoY on Thursday.

NZD/USD looks set to target the 2013 high of 0.8676 as the next key target, a level that will provide strong resistance.

RBNZ sends a hawkish message

The RBNZ delivered few surprises by raising policy rates by 25bps to 2.75% overnight. The decision was widely expected but nonetheless managed to give further support to the NZD. The kiwi benefitted from a relatively hawkish statement, with the central bank stating that rate hikes totalling 125bps are likely over the coming months while revising higher its growth and inflation forecasts.

Despite some jawboning to talk the NZD lower RBNZ governor Wheeler noted that opportunities for FX intervention were low. Gains in the NZD look impressive given the headwinds from growth worries in China and lower commodity prices but downside risks remain limited, with NZD/USD set to sustain a move above 0.8500 in the near term. Also positive for NZD is the fact that milk prices continue to remain well supported.

The week ahead

There are plenty of events to chew on over coming days including central bank decisions in Japan tomorrow and New Zealand on Wednesday. The Bank of Japan is unlikely to ease policy further so soon after its actions to boost loan growth while in contrast the RBNZ is set to begin its hiking cycle. On the data front US releases will still be weather impacted to some extent although February retail sales is likely to post a small gain. Moreover, Michigan confidence is set to rise, boosted by higher equity prices.

In Europe, attention will focus on industrial production releases in January, with French and Spanish IP data due to be released today. Overall production is likely to have expanded at a healthy clip of 0.4% MoM in the Eurozone as indicated by survey data. Finally, Australian jobs data is set to show some improvement on Thursday as the pace of deterioration in job market conditions slows.

In Asia the reverberations from the weaker Chinese data will likely impact sentiment across the region. Exports dropped by whopping 18.1% in February while imports rose more strongly than expected at 10.1% yielding a trade deficit of USD 22.99 billion. Central bank decisions in Korea and Thailand are on tap this week. Thailand is a close call, with risks of another policy rate cut but we expect the BoT to stay on hold. Currencies in Asia strengthened last week led by the IDR and INR. Gains this week will be morel limited, especially against the background of higher US yields.

Some respite for emerging market assets

Large gains in many emerging market currencies have been registered in the wake of policy rate hikes in Turkey and to a lesser extent in India. Also some encouraging data in Asia in particular a widening in South Korea’s current account surplus helped to shore up confidence in regional currencies. Not wanting to throw cold water on the move but while everyone is lauding Turkey for its bold move the reality is that its aggressive rate hike will hit growth at a time when its economy is fragile.

The massive rate hike in Turkey (repo rate hiked from 4.5% to 10%) fuelled a bounce in risk appetite nonetheless, although most risk measures have only reversed part of the move registered over recent days. It is way too early to suggest that everything is returning back to normal and the rally in risk assets looks vulnerable to fading out over coming days.

While I am not a proponent of the nervousness in emerging markets turning into a renewed crisis, uncertainty about country specific issues such as slowing growth and deleveraging in China, fundamental and political uncertainties / elections in Thailand, India, Indonesia. Ukraine and countries in the “fragile 5” against the background of Fed tapering, suggest rocky times ahead.

Moreover, the market may have priced in another $10 billion of Fed tapering today but the reality is that the global liquidity injections provided by the Fed will be reduced over coming months. Additionally a likely renewed rise in US Treasury yields will add another layer of pressure on emerging market assets.

Although emerging market currencies have strengthened most G10 currencies remain in a tight range. G10 FX gains were led by the AUD and NZD while JPY came under renewed pressure. This pattern is likely to continue in the near term. Aside from the Fed FOMC there will be some attention on the Reserve Bank of New Zealand too. The RBNZ is expected to keep policy rates unchanged but there is a small chance of rate hike or at the least a hawkish accompanying statement which ought to keep the NZD supported.

Bad news is good

Risk assets retained their positive performance into the end of last week, with US equities closing the week higher and the VIX ‘fear gauge” closing lower while 10 year US Treasury yields continued to pivot around 2.5%. Meanwhile the USD remains on the back foot finding little help from data releases especially last week’s September employment report. Friday’s release of September US durable goods orders similarly disappointed, with core orders coming in weaker than anticipated. The bad news is good philosophy of markets means that weaker data is helping to aid expectations that Fed tapering may be delayed, in turn boosting risk assets.

This week will bring much of the same. There are a plethora of US data releases on tap including September industrial production today, retail sales, CPI inflation and October consumer confidence and ISM manufacturing. Additionally there is a Fed FOMC meeting this week although no surprises are expected at this meeting. US data releases will look relatively soft but given the market mood this will bode well for risk assets. The jury is out with regard to the timing of tapering but increasingly many are looking for it take place in Mar/Apr 2014.

Europe has a more limited data calendar including the Bank Lending Survey of credit conditions and economic sentiment indicators. These will look a bit more positive than previous months. In Japan September jobs data and industrial production are on tap. Additionally two central bank meetings from the Bank of Japan and RBNZ will not result in any surprises, with policy set to remain unchanged.

It is difficult to see the USD achieving much of a recovery against the background of relatively weaker US data releases although it does appear that a lot of bad news is already priced in. The fact that US Treasury (10 year) yields have stabilised around 2.5% will help to limit any further downside pressure on the USD. Moreover, even if US data are softer this week, much of the market has already pared back tapering expectations into next year, suggesting little scope for expectations of a further tapering delay.

USD/JPY is finding some support around its 200 day moving average at 97.38 and given the stability in US yields will find some support in the near term. EUR/USD remains supported and will likely benefit from more encouraging Eurozone data releases this week but gains above 1.3800 are beginning to look increasingly stretched. GBP/USD pulled back from its highs around 1.6248 last week despite a reasonably good 0.8% QoQ Q3 GDP reading. This week’s UK data is likely to be little softer, with manufacturing confidence (PMI) likely to edge lower for a second straight month, a factor that could undermine GBP further.

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