Buy AUD-NZD – Standard Chartered

According to analysts at Standard Chartered, AUD-NZD has diverged from 2Y swap spreads, to a degree that they think is unsustainable and recommends a long AUD-NZD trade; current spot ref: 1.0850; spot target: 1.1300; spot stop-loss: 1.0690.

Key Quotes

“Big picture AUD-NZD mostly tracks the AU-NZ 2Y swap spread. Past divergence from this spread has been driven by the following factors (1) 2006: a sharp relative movement in current accounts; (2) 2007: initial FX intervention by the Reserve Bank of New Zealand (RBNZ); (3) 2011-12: substantial offshore demand for Australian government bonds; and (4) 2016: the end of a once-in-a-generation drop in iron ore prices.”

“As none of these one-offs are in evidence, we expect AUD-NZD to recover to where rate spreads suggest it ‘should’ be, closer to 1.15. Further underpinning this is a large move in the relative current account positions in favour of the AUD, which we examined in detail in February. February’s record trade surplus suggests that Q1 may indeed print Australia’s first current account surplus since Q2-1975.”

“On the NZD side, we believe the currency remains overvalued. Recent declines in dairy prices have offset the currency weakness to prevent the valuation gap from closing. Unsurprisingly, the RBNZ called for further depreciation at the March policy meeting. The RBNZ remains sensitive to currency strength due to its deflationary impact via tradables inflation, which constitutes 45% of New Zealand’s CPI basket. We expect the RBNZ’s currency rhetoric to keep the NZD under pressure.”

“Further, we think the market is overpricing RBNZ rate hikes, with 50bps of hikes priced in by mid-2018. This is in contrast with the RBNZ’s own projections that show policy rates on hold for two years. The central bank has noted little need for near-term policy tightening as it expects a gradual improvement in inflation; CPI inflation is not expected to reach the 2% mid-policy band until Q2-2019. The market has pared rate hike expectations recently after the RBNZ stressed it would be on prolonged hold and called market rate pricing excessive. We see room for further correction in front-end NZD rates, which should weigh down the currency.”

“We recommend a medium-term long AUD-NZD trade; current spot ref 1.0850; spot target 1.1300; spot stop loss 1.0690.”