NZD and AUD: It’s all about carry - Rabobank

Jane Foley, Research Analyst at Rabobank, suggests that the initial surge in the value of the NZD on the back of the RBNZ’s 25 bps rate cut yesterday morning can easily be explained by a build-up in speculation this week that a larger rate hike could have been on the cards.

Key Quotes

“According to the swaps market the market had priced-in a 20% chance of a 50 bps move. While this is a valid explanation, there are other forces at play in the market that are lending support to both the NZD and the AUD.

As we have pointed out before, the AUD and the NZD have been the best performing G10 currencies since the announcement of the results of the UK’s EU membership referendum on June 24. This event has been significant in sparking speculation of another round of easing by various central banks including the ECB and the BoE.

Last night’s Monetary Policy Statement from the RBNZ was littered with dovish statements. Global growth was seen to be below trend, low dairy prices are depressing incomes and domestic annual inflation is expected to weaken in the September quarter. These remarks are despite the fact that the RBNZ reports that “domestic growth is expected to remain supported by strong inward migration, construction activity, tourism and accommodative activity”. These factors would appear to place the NZ economy in a better position to most of the developed world and would on first sight appear out of context with the RBNZ’s warning that “our current projections and assumptions indicate that further policy easing will be required to ensure that future inflation settles near the middle of the target range”.

We would argue that the link between these two viewpoints is the stubborn resilience of the NZD to which the RBNZ devote a paragraph to in last night’s policy statement. The RBNZ states that “the high exchange rate is adding further pressure to the export and import-competing sectors and, together with low global inflation, is causing negative inflation in the tradables sector. This makes it difficult for the Bank to meet its inflation objective. A decline in the exchange rate is needed”.

The impact of the carry trade is no secret. The RBNZ says that “weak global conditions and low interest rates relative to New Zealand are placing upward pressure on the New Zealand dollar exchange rate.” Clearly a hike in the Fed funds rate would be welcomed by the RBNZ and the RBA which is in a similar position. To be on the safe side, however, we expect both the RBA and the RBNZ to cut rates again this year, potentially aggressively. Our house forecast of a Fed rate hike in Dec suggests feeds our view that NZD/USD can push to 0.69 on a 6mth view. However, without a Fed move, the NZD/USD will likely struggle to move below 0.70 even on further RBNZ rate cuts.”