Australian Dollar: Faces corrective phase versus New Zealand Dollar – MUFG

MUFG’s Derek Halpenny and Abdul-Ahad Lockhart report that the AUD/NZD rally may have peaked as rate differentials begin to turn. They stress that the Reserve Bank of New Zealand (RBNZ) signalled forthcoming hikes, while the Reserve Bank of Australia (RBA) can pause longer. Their empirical work suggests that if spreads compress, the recent sharp AUD/NZD drop could mark the start of a broader downside correction.

Rate spread turn threatens AUD/NZD gains

"We covered the Australian dollar in the FX Weekly (here) that we released on Monday with the key message that the strong gains for the Australian dollar may be coming to end and that if rate spreads as a driver of FX was returning as a more dominant driver then there were potential headwinds ahead for AUD."

"The RBNZ meeting yesterday potentially marked a turn in that spread, which is likely to see some of that near 14% gain in AUD/NZD reverse. The RBNZ made clear that a hike was coming and the split 3-3 vote that kept the policy rate unchanged at 2.25% (Governor Breman’s vote to hold swung the decision) was accompanied with a communication of hikes to come."

"We see a hike at the next meeting in July, which is not yet fully priced at 20bps. By September market pricing shows 40bps of tightening and we see a good chance now of back-to-back hikes given the messaging at the meeting this week."

"Some investors remain sceptical given the mixed economic conditions. That’s a valid argument and the 110bps of hikes by March 2027 may not be delivered but getting to a more neutral stance over the short-term is a reasonable near-term objective for the RBNZ."

"Our empirical analysis highlights that downside moves in AUD/NZD incur different implications depending on whether they are confirmed by rate differential compression. Historically, when large declines in AUD/NZD (greater than 1 std) have coincided with a meaningful tightening in the AU-NZ 2yr spread, the move persisted with 4-week forward returns averaging -0.6%."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)