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The Week Ahead in FX Markets – Kiwi takes a breath, but remains on edge

Published November 12, 2018

By Phil Lynch

The New Zealand dollar has weathered a stormy November so far and opens today 3.4% higher than where we started the month just 12 days ago. The events to date will likely have a lingering impact on the New Zealand dollar, with the most notable changes being the Democrats taking control of the House of Representatives, and the staggeringly good 3.9% Unemployment Rate in New Zealand.

Ahead of us this week, we have another busy week of economic data releases. However, this week packs less of a punch than that of recent weeks. Whilst volatility can never be ruled out, we can hope for more of a consolidation this week.

The Kiwi – Fair Value?

The NZDUSD’s recent climb into the 0.67’s came quickly but was arguably well deserved for the New Zealand dollar. President Trump has been driving a “stronger” US economy, through spending, tax cuts, and ignoring the elephant in the room: debt. The US midterm elections rightly caused uncertainty for markets, and for the US dollar. This uncertainty could very well linger, as the Republicans and Democrats trip over each other within the US political system. So yes – a higher kiwi is well justified given the uncertainty in US politics that had previously been fuelling a stronger USD.

However, it is also expected the strength in the US economy will remain, and this will, in turn, continue to drive the Federal Reserve’s rate-tightening program, and drive US dollar strength over the long-term.

Locally, however, the Unemployment Rate data flew in the face of the RBNZ’s supposed ‘dovish’ stance. It also flew in the face of the Business Confidence surveys negative outlook. It is also on the back of other strong data released recently such as NZ CPI which came in at 1.9% vs expectations of 1.7% when it was published a month ago. There is no question that the RBNZ take a long-term outlook when making monetary policy decisions, but this Unemployment Rate data has shifted the expectation.

The rise in the kiwi into the 0.67’s is therefore well justified right now. Continued strength in the kiwi can be expected if local economic data continues to outperform. The question is – can we keep pace with the US?

The Week Ahead

This week looks relatively simple compared to recent weeks, despite the many tier one economic releases on the calendar. The highlight for the NZDUSD will likely be US Consumer Price Index data released on Thursday morning. The US Federal Reserve uses these inflation numbers as a key indicator in their monetary policy decisions.

Elsewhere it will be the Australian dollar that is worth watching. Key data this week includes releases from both Australia and China. Most notable will be the Australian employment data, which includes the Wage Price Index on Wednesday, and the Unemployment Rate on Thursday. Markets, as a whole, expect the Unemployment Rate to rise to 5.1%. However, the same analysts that are expecting 5.1% were expecting the NZ Unemployment Rate to come in at 4.5% last week – and it came in at 3.9%.

The Interest Rate Spread – Chart of the Week

We often talk about interest rates being a key driver of exchange rates. This relationship is particularly well demonstrated by the benchmark 2-year treasury yield. With US 2-year interest rates rising, and NZ 2-year interest rates staying relatively flat, the spread between the two interest rates has fallen. For example, back in January 2018, US and NZ interest rates were even. Now, however, US interest rates are almost 1% higher (taking the NZ-US spread to -1%). When plotted on a chart, you can clearly see the correlation with the New Zealand dollar’s movements. So if you want to get an understanding of ‘where to’ for the New Zealand dollar, it is very useful to keep tabs on ‘where to’ for US and NZ interest rates.