Since March 2009, we have seen global equity markets rise nearly 60% and commodity prices increase in similar proportions, while short-term government bond yields have continued to decline. In the major G-10 currency markets, the higher yielding, higher beta commodity currencies (Australia, New Zealand, Norway and Canada) have outperformed the lower-yielding, more developed countries that have engaged in the most fiscal stimulus (US, UK, Japan). The above has been characterized as a “risk on” environment. Inversely, from June 2008 to March 2009, the exact opposite, characterized as “risk off,” was the case.
So how do we trade these markets while the policy makers try to figure out what to do next? For the time being, it appears the future direction of the currency markets lies in the hands of broader market risk.
The CRB Reuters Commodity Index and broad equity markets are a good barometer for global risk appetite. Both of these have moved higher since March 2009 fueled by improving economic data, Asian demand, and money leaving bonds and bank savings accounts which no longer have desirable yields, in search of positive returns. In this environment, the Australian dollar and Norwegian Kroner appear to be in the best position of the G-10 currencies. These countries have begun raising interest rates and produce what the world wants and needs in natural resources. Australia specifically is exporting to the fastest-expanding region, the Far East, and thus their currency has and should continue to gain.
In a “risk off” environment, I prefer to sell the New Zealand dollar. This is a currency which has been dragged along higher with the Australian dollar. Since March, they are both up nearly 45% vs. the U.S. dollar. The market often trades and thinks of them as linked due to their close geographic proximity. In the past they have had similarly high interest rates compared to other G-10 currencies and they are both export-led natural resource rich countries (see below chart).
While all of that is true, the issue is they have very different trading partners and produce and export very different goods. Australia exports coal, iron ore, gold, aluminum and wheat to China (17%), South Korea (11%), and India (8%). New Zealand on the other hand exports dairy products, meat and wood to Australia (23%), the United States (10%) and Japan (8%). Thus they have very different local economic situations. New Zealand has suffered from four consecutive quarters of recession while Australia had just one and is already experiencing positive growth. Looking at the technicals, the Aussie dollar broke its downward trendline against the kiwi at the end of October and held that level in the middle of November indicating further strength (see chart). The Reserve Bank of New Zealand has been very vocal about stating the above dilemma as well as the fact that they do not intend to raise interest rates until the second half of 2010 at the earliest, while the market expectation is for the first quarter of 2010. The New Zealand dollar is ripe for a large move lower but timing is very important.
Possible triggers for risk assets to reverse the current nine-month up trend would be growth falling short of expectations, central banks publicly forecasting an end to low interest rates, inflation or deflation fears picking up, various governments to end or slow stimulus spending, renewed bank fears, or a geopolitical event. Look for market confirmation in the dollar index moving higher while equity and commodity prices move lower. In this environment I would look for volatility to increase and the New Zealand dollar to be the currency in the G-10 to decline most vs. the U.S. dollar.
The 0.6000 level has been a historically important pivot area for the New Zealand dollar (see chart below), which could serve as a long-term target once the current nine-month bull trendline is broken.
