- Market pricing suggests the RBNZ is likely to cut policy rate to 1.75% in November
- There's an even chance the RBA will cut its rate to 1.25%
- Dairy prices are rising strongly and iron ore appears to be topping out
- A trading opportunity is emerging to sell AUDNZD with parity as a target
By Max McKegg
FX traders are waiting around for Friday’s US employment report, expecting (hoping) it will jolt the USD crosses into action. The consensus forecast seems to be a jobs added number of 180,000 and an unemployment rate of 4.8%.
No doubt we will see a lot more second guessing in the lead up. But remember it’s the initial print that determines the response (not the often big revision a month later) and a look back over the last 20 years shows only one occasion when the initial print exceed 200,000. Yet to give impetus to the dollar rally, that is what we would need to see.
Coming together ... New Zealanders could be celebrating a parity party by the end of this year
as the Aussie underperforms. Photo: iStock
Rather than participate in that crap shoot, I’m looking at a couple of non-dollar crosses that have interesting setups. Take AUDNZD
for example. This chart (click to enlarge) shows a pattern very similar to late 2014, suggesting New Zealanders could be celebrating a parity party by the end of this year as the Aussie underperforms.
Do the fundamentals back up the technical picture? It depends at the data points you look at, but take that old favourite, interest rate differentials for example. Neither Reserve Bank is expected to cut its policy rate in September but Overnight Index Swap pricing suggests a close to 50:50 chance the Reserve Bank of Australia will do so in November and a 75% chance the Reserve Bank of New Zealand will follow suit. On the face of it, a slight advantage for the AUD then.
However, as we know, “yield convergence” is driving the international capital markets now and outright return, not spreads, is the driving force behind FX crosses. This was well illustrated a couple of days ago when the New Zealand government issued an April 2037 bond at a yield of 2.91%, way above its G10 counterparts and a decent spread over the Australian equivalent.
No surprise then that offshore investors gobbled up 85% of the issue. On that basis then the pendulum swings back in favour of the NZD.
Source: Bank of New Zealand
The other driver of the AUDNZD cross is relative commodity price movements, especially those for dairy and iron ore. This chart shows dairy prices are up 40% this year and, just as important for farmer bottom lines, they are still nicely ahead even taking into account a stronger NZDUSD
. Futures pricing suggests further improvement in next week’s Global Dairy Trade auction.
Source: Bank of New Zealand
As for iron ore, prices continue to hold around $60/tonne, despite doom and gloom predictions from analysts earlier in the year. Chinese steel production has beaten forecasts, inventories have been at low levels and local production of iron ore is down. But these issues are expected to even out as the year progresses and the consensus among Australian producers is that iron-ore prices will slip to around $40, a view shared by the RBA in its latest economic forecasts.
This medium-term chart of iron ore looks similar to AUDUSD
(click to enlarge). Both bottomed out late last year and have been grinding higher since.
Earlier this year investors based in negative rate countries who got in quick were able to buy Australian and New Zealand bonds on a fully hedged basis and lock in a positive yield. But those days are gone. With all the demand coming from the same side, cross currency basis swap spreads have blown out. Now investors would end up with a deeper negative yield than they would get in their home market. This means we are likely to see more outright buying of the Aussie and Kiwi as the convergence trade drives their bond yields closer to the global average.
Source: Morgan Stanley
Market pricing suggests the RBNZ is likely to cut the policy rate to 1.75% in November, with an even chance its Australian counterpart will cut to 1.25%. In a yield starved world that will not take the pressure off either currency. But with dairy prices rising strongly while iron ore appears to be topping out, there seems to be a trading opportunity to sell AUDNZD with parity as a target.
– Edited by Gayle Bryant
Max McKegg is managing director of Technical Research Limited. If you would like an email notice each time Max posts a trade or article then click here or post your comment below to engage with Saxo Bank's social trading platform.