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Cross-Check: AUD/NZD – Bouncing back

After falling away sharply over the past few weeks AUD/NZD looks to be bouncing back to life. A key catalyst behind the drop in AUD/NZD to multi-quarter lows recently was the NZD supportive upward repricing in NZ interest rate expectations as markets factored in a chance the normally cavalier RBNZ re-starts its hiking cycle. In the end, at today’s meeting, the RBNZ clipped the markets ‘hawkish’ wings. The RBNZ’s Official Cash Rate was held steady at 5.5%, and the underlying tone and updated forecasts watered down the prospect of further tightening this cycle. The implied odds of another rate rise inferred from the RBNZ’s interest rate projections was trimmed rather than added to with the start of an easing cycle still penciled in from H1 2025. In the RBNZ’s view, while the “OCR needs to remain at a restrictive level for a sustained period” to win the battle against inflation, it “remains confident that the current level” is restricting demand. As Governor Orr also noted demand now better matches supply and while risks still exist NZ looks to be “in a disinflation period”.

From our perspective, as it was a pillar behind the NZD’s recent outperformance (and fall in AUD/NZD), the unwind of ‘hawkish’ RBNZ bets are set to generate renewed support for AUD/NZD. We think the reduction in ‘net short’ NZD positioning (as measured by CFTC futures) on the view the RBNZ might raise rates after being on hold for an extended period can easily be built up again. This in turn would weigh on the NZD. In our judgement, the hurdle for AUD/NZD to snap back up towards its 1-year average (~$1.08) isn’t high. FX is a relative price, and a range of fundamental indicators such as longer-dated interest rate spreads, commodity prices, and other macro trend gauges already suggest AUD/NZD is too low. We believe the mispricing in AUD/NZD should fade over the period ahead.

This is more than just a short-term story. In our judgement, the AUD looks set to appreciate against the NZD over the longer-term as well as Australia’s economy holds up better than NZ’s. The RBNZ’s more aggressive approach (compared to the RBA) during the rate hiking phase is gaining traction. NZ growth momentum should continue to slow as the RBNZ’s ‘restrictive’ stance continues to bite down across the private sector. The RBNZ is predicting very weak growth until late-2024. In time, this should see NZ labour market conditions loosen, wages slow, and domestic price pressures ease. We think this will open the door to the RBNZ delivering more interest rate relief than the RBA during the next easing cycle, and as our charts show, relative growth and labour market swings are forecast to move in Australia’s favour. This has historically been associated with a rising not a falling AUD/NZD.

Additionally, NZ’s substantial current account deficit (~7.6% of GDP) is quite unfavorable compared to Australia’s surplus position (~1.2% of GDP), and this external imbalance may leave the NZD more vulnerable during any bouts of renewed market turbulence. A revival in China’s economy, especially if it is lead by commodity intensive infrastructure spending, is also normally more of an AUD tailwind. Things won’t move in a straight line and bumps along the way are probable, but, over the medium term we see AUD/NZD trending up towards ~1.10-1.12 later this year.

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