New Zealand Dollar slips as safe-haven demand lifts the US Dollar

• The New Zealand Dollar extends its decline for a second consecutive session as the US Dollar strengthens.
• Rising geopolitical tensions in the Middle East support demand for safe-haven assets despite mixed US economic data.
• Softer New Zealand employment figures reinforce expectations that the central bank will tighten policy only gradually.

NZD/USD trades around 0.5880 on Thursday at the time of writing, down 0.10% on the day. The pair remains under pressure as renewed demand for the US Dollar (USD) emerges, with investors seeking safe-haven assets amid fresh geopolitical tensions in the Middle East. An Israeli airstrike in southern Lebanon has reignited risk aversion, although reports that Iran and Oman are finalizing an agreement on a temporary shipping route through the Strait of Hormuz have helped ease concerns over prolonged disruptions to energy supplies.

The US Dollar is benefiting from this defensive positioning despite another round of mixed US economic data. Initial Jobless Claims edged up to 199K last week from a revised 198K previously, but came in below market expectations of 202K. The release follows Wednesday's weaker ADP employment report. Investors are now turning their attention to Friday's Nonfarm Payrolls (NFP) report for a clearer assessment of US labor market conditions.

Markets continue to scale back expectations for another interest rate hike from the Federal Reserve (Fed). According to the CME FedWatch tool, the chance of a 25-basis-point rate increase in September has fallen to 56.9% from 63.4% a week ago, as traders increasingly believe that the gradual cooling in the labor market could encourage the central bank to adopt a more cautious approach.

Meanwhile, the New Zealand Dollar (NZD) remains weighed down by weaker-than-expected employment data. The report reinforces expectations that the Reserve Bank of New Zealand (RBNZ) will continue to tighten monetary policy at a gradual pace, although markets still fully price in a 25-basis-point rate hike at the September meeting. Policymakers recently indicated that further tightening may still be required to bring inflation fully under control.

NZD softens as labor slack persists but RBNZ tightening bias holds

Strategists at BBH note that “NZD and NZ yields slump” in the wake of New Zealand’s latest labour market data, arguing that “solid Q2 job and wage growth mask ongoing labor market slack.” They highlight that employment “surged 0.5% q/q vs. 0.1% in Q1, well above consensus and RBNZ projection of 0.1%,” while “private regular wages were up 0.7% q/q (consensus & RBNZ: 0.6%) vs. 0.5% in Q1.” However, BBH stress that “strong hiring was more than offset by rising labor supply,” with the participation rate “rose 0.2ppt to 70.7%,” which “lifting unemployment and pointing to excess labor supply.” In their view, the labour market slack is underscored by the fact that “the unemployment rate rose 0.2ppt to 5.6% (consensus & RBNZ: 5.4%), the highest since Q3 2015 and the underutilization rate increased 0.9ppt to 13.8%, the highest since December 2013.”

Despite the softer currency and higher jobless rate, BBH argue that “NZD has room to keep edging higher against most major currencies,” citing “above target inflation, more favorable domestic growth outlook, and a policy rate near the lower-end of the RBNZ’s neutral range (2.20%-4.10%)” as factors that “argue for additional RBNZ rate hikes.” They note that “the swaps curve price in nearly 100bps of cumulative tightening over the next twelve months to 3.50%.” TD Securities concur that policy tightening remains on the table, stating that “despite the mixed report today, we believe the RBNZ has the room to hike again by 25bps in September given that economic activity continues to recover in Q3.”