DB FX Daily: London Eurodollar strip and EUR/USD; RBNZ and NZD

[RTFX-Trading]

FX Daily: London

Eurodollar strip and EUR/USD; RBNZ and NZD

Today's Key Data and Events
GBP Net consumer credit for April, GBP1.0bn expected (08:30 GMT)
EUR HICP flash estimate for May, 1.9% expected (09:00 GMT)
USD GDP, prelim. Q1 estimate, 0.7% expected (12:30 GMT)
CAD GDP for Q1, 3.8% expected (12:30 GMT)
USD Chicago PMI for May, 55 expected (14:00 GMT)

Upcoming Event Risks
June 1: US Non-farm payrolls, ISM, core PCE
June 6: ECB rate decision, RBA rate decision
June 7: Bank of England rate decision
June 14: SNB rate decision

Shape of the Eurodollar strip and EUR/USD
Despite the 2 year swap rate differential between the Euro zone and the US having been largely unchanged since the end of April, EUR/USD has pulled back over the past month from 1.3650 to around 1.3430 currently, with the 20 day trailing correlation between EUR/USD and the 2 year rate spread near zero. However, if we plot the shape of the Eurodollar strip against EUR/USD (see the first chart below), it becomes apparent that not only does the interest rate differential between the Euro zone and the US drive EUR/USD, but that the shape of the Eurodollar strip also matters. This also appears to be particularly the case when the Fed is on hold. Indeed if we examine a 20 day trailing correlation (not shown) between the shape of the Eurodollar strip and EUR/USD we see a reasonably tight relationship since the second half of 2006 - that is, broadly corresponding to the period that the Fed has been on hold.

Looking at the chart below it becomes apparently that the recent peak in EUR/USD corresponded with the peak in inversion between the 2nd and 4th Eurodollar contracts. Similarly the move lower in EUR/USD since late April has been associated with a steepening in the Eurodollar strip (although it still remains inverted). This steepening in the Eurodollar strip has been largely driven by the sell off in the longer dated contract and likely reflects the recently improved tone to the US data flow that has seen medium term expectations for Fed easing scaled back. The implication for EUR/USD therefore appears to be that in the absence of some weaker data to get Fed easing decisively back on the agenda, EUR/USD may continue to struggle. As far as US data days come, few loom as large as Friday - with payrolls, the ISM and the core PCE deflator all on the docket.

RBNZ announcement next week next big event for NZD
We have been expecting AUD/NZD to be mostly range bound in coming weeks between 1.11 and 1.1450, partly because the market appears cautious on NZD long positions. We suspect this is due to the risk that the recent tightening in NZ financial conditions results in a softer NZ data going forward. Today's NBNZ business survey then, which was very soft in tone, may reinforce these concerns. Not only did the headline index fall to -48.3 from -19.4, but the key own activity measure slumped to 7.8 from 22.5. This also reinforces the likelihood that the RBNZ will leave rates unchanged at its meeting next Thursday, and with this still being priced by interest rate markets as around a 25% chance, we look for a move in AUD/NZD to 1.1425.