The Aussie Dollar (AUD) and the Kiwi Dollar (NZD) usually exhibit a fair degree of positive correlation. Their economies share similar characteristics and more importantly are relatively integrated to allow forces in one economy to spill over into the other. There are differentiating factors of course most notably the fact that Australia’s economy is 6 times larger than that of New Zealand. So too Australia’s trading relationship with China has an important influence upon real money flows in Australia and sentiment. In today’s market, there is another rift opening between the two economies and it’s having a significant impact upon the valuation of both currencies in markets. However, I question whether that might be due to change in the relatively near future.
Australia has one of the most ‘oversold’ currencies when considered from the perspective of open market interest. Some 46% of net open market interest surrounding the Aussie Dollar is positioned short which could leave a lot of room for catch up and a so-called short-squeeze if the conditions present themselves. In contrast, the usually correlated New Zealand Dollar is the most overbought currency when measured by the same metric with a net 31% of open market interest looking for an appreciation in the Kiwi. Both of these positionings are well outside of the one standard deviation mark for the respective currencies and whilst not quite at the maximum of their 5-year ranges, they’re dangerously close. Small changes in sentiment could therefore allow rapid correction in spot positioning and therefore convergence in prices.
The reason for the divergent positioning is the upside and downside surprise respectively in the published and expected path of monetary tightening in New Zealand and Australia respectively. Australia if you recall surprised markets by only removing a portion of yield-curve control and not taking a more convincing step towards normalisation. New Zealand on the other hand has benefitted from meaningful monetary tightening, raising its rates for the first time in seven years by 25-basis points last month. Despite the risks of economic re-opening in Australia distorting data and providing an elongated recovery, there is a lot of room for Australia to relatively easily close the gap. This extreme positioning in NZD and AUD markets could therefore force turbulent conditions within these crosses but ultimately, it seems, correct the divergent fortunes of these two currencies.
Discussion and Analysis by Charles Porter