Dollar dangers down under

August 3, 2015 09:00 AM

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The AUD/NZD cross is one of the most trend-driven pairs in the currency markets and the climb from April’s record low of 1.0020 is the start of a new big trend. The NZD suffered a fresh bout of losses in mid-June after the Reserve Bank of New Zealand (RBNZ) surprised with a 25-basis point rate cut to 3.25% — its first interest rate reduction in four years. The currency remains pressured by the clear message by the RBNZ: “Further easing may be appropriate ... the exchange rate has declined from its recent peak in April, but remains overvalued.” Since the RBNZ’s statement, traders rushed to sell NZD despite the 21% decline in the kiwi since last summer. 

Interestingly, in light of the 50% decline in New Zealand dairy prices (New Zealand is the world’s biggest exporter of dairy products), the kiwi may have another 10% to 15% to fall, considering the 65% decline in dairy prices since 2009 triggered a 63% plunge in the currency. As the RBNZ disrupts the kiwi’s high-yield status in a zero-yield world, the exodus from New Zealand assets could be violent. 

In fact, Japanese investors have already begun reducing their exposure, after they trimmed their New Zealand government bonds by 0.4% to NZ$ 2.11 billion in May, according to RBNZ data. Money managers in Belgium, Luxembourg and the Netherlands collectively cut their holdings by 1.5% to NZ$37.9 billion. 

The ensuing shift in the market’s thinking to anticipate a second RBNZ rate cut to occur as early as July had been magnified by the concerted policy easing in Asia and throughout New Zealand’s partners, combined with the RBNZ’s relatively lofty rates, which bolsters the prospect for the central bank to reverse all of last year’s 100-basis points in rate hikes by early next year.

On the Aussie side of the AUD/NZD coin, a stronger than expected rise in May employment payrolls  coupled with the plunge in the unemployment rate to a 12-month low of 6.0% delivered a robust support to the Aussie. Royal Bank of Australia (RBA) Governor Glenn Stevens’ efforts to talk down the currency may dissipate if the jobs figures continue to improve. Additional rate cuts in 2015 are no longer assumed. 

Aussie bears may argue for prolonged easing in light of the deteriorating Q1 capital expenditures, showing a 4.4% contraction (biggest since Q4 2013). The figure was especially alarming as it was accompanied by a larger than expected decline in planned capital expenditure intentions for 2015-16 in both, mining and non-mining sectors. The latest private forecasts on 2015-16 capital expenditures have ranged from -20% to -35%, well below the -10% projection in the latest RBA Statement of Monetary Policy.

Considering that deterioration, the RBA may have little choice but to cut rates. The three main reasons for not expecting any more easing from the RBA this summer are: One, Aussie’s sharp depreciation is already in line with the RBA’s forecasts; two, jobs and home prices remain firm and three, the RBA could afford the luxury to save its policy armory and rely on the trade pass-through from further currency depreciation, particularly if the People’s Bank of China’s recent decision to refrain from injecting liquidity becomes a habit.

“Kiwi crater” highlights that there is greater dowside for RBNZ than for RBA policy rates, which correlates between the AUD/NZD cross and the RBA-RBNZ interest rate spread. The break above the 100-week moving average in AUD/NZD paves the way to the top of the March 2011 channel, suggesting $1.1220 as a preliminary target, followed by $1.1450. 

An alternative approach to backing the AUD/NZD trade is seen from ample downside in NZD/USD ($0.66 at the 200-month moving average) and ($0.62 at the 2006 lows) in contrast to $0.75 limited downside for AUD/USD; the case for higher AUD/NZD remains evident, but will take time.

About the Author

Ashraf Laidi is chief global strategist at City Index-FX Solutions and author of “Currency Trading & Intermarket Analysis.” His Intermarket Insight appears daily on AshrafLaidi.com.