Market Musings: Cross-Check: AUD/NZD - Re-Entry Point
AUD/NZD has trended higher over the past few months, rising by ~6% from its mid-December low to its recent highs. In reaction to a quick-fire combination of weaker than predicted Australian wages data and another 50bp rate hike by the RBNZ AUD/NZD has slipped back below its 200-day moving average (1.1003). While a further pull-back in AUD/NZD looks likely in the near-term, as markets continue to digest the RBNZ announcement, we think it should be modest with the region around the 100-day (1.0861) and 50-day (1.0846) moving averages expected to provide downside support. Beyond the shorter-term gyrations, our bigger picture view is still for the NZD to underperform over coming quarters, and for AUD/NZD to push higher (up towards ~1.15) as 2023 rolls on. Central to this view is our thinking that the RBNZ, who remains laser-focused on bringing down inflation no matter the economic cost, will end up overdoing it, triggering a steep downturn and sharp rise in NZ unemployment. Indeed, what seems to have been lost somewhat in all the rate hike focus, is that this remains the RBNZ’s baseline outlook. As the chart below shows, the RBNZ continues to project the Official Cash Rate (now 4.75%) to reach ~5.5%. This will put policy settings well into restrictive territory, and in turn, the RBNZ is penciling in a NZ recession in late-2023, with sub-trend growth anticipated over the next few years. As the RBNZ’s aggressive steps take hold and a NZ recession materialises, we think markets (and the RBNZ) will progressively shift away from focusing on upside inflation risks and how high rates could end up, and begin to pay more attention to downside growth concerns and contemplate how quickly a policy easing cycle may unfold. We think the RBNZ will stop hiking at ~5.25%, after a couple of more 25bp moves, by which time evidence that higher interest rates are restraining demand should be piling up. And we believe there is a growing possibility the heavy-handed RBNZ could look to start taking back some of its forceful tightening in late-2023/early-2024.
Our thinking is that in time, particularly as economic slowdowns materialise around the world, FX markets could become more attentive to other relative differentials such as growth and labour market trends, and commodity prices, in addition to interest rate spreads. And on this broader basis, the NZD should lose out to the AUD, in our opinion. On the growth front, the RBNZ moved earlier and has acted more aggressively than the RBA so far this cycle. In our mind, this should also mean the economic impacts are larger and felt sooner in NZ, and this arguably may also open the door to an earlier RBNZ rate cutting cycle. In contrast to the RBNZ, although the RBA is talking tough on inflation at present and has flagged further rate hikes are in the pipeline, Governor Lowe has also emphasized a desire to travel the tricky narrow path where the Australian economy slows enough for inflation to be on a track down to target, but not too much whereby labour market gains aren't preserved. This divergence is clearly illustrated by the RBA’s and RBNZ’s unemployment rate forecasts. The RBA is looking for Australian unemployment (now 3.7%) to drift up to ~4.5% by mid-2025, with the RBNZ predicting NZ unemployment (now 3.4%) to reach ~5.7% over the same time frame. The labour market provides a snapshot of wider economic trends, and is a key input into the policy outlook. Unemployment swings have historically provided a good guide to medium-term AUD/NZD direction, with a relatively lower Australian unemployment rate typically an environment where the AUD outperforms the NZD. Although we think the RBA’s projections may prove to be too optimistic and Australian unemployment ends up lifting by more than it is thinking, we don’t expect it will reach as high as the RBNZ is seemingly willing to allow NZ unemployment to get to. Hence, so while the AU-NZ unemployment rate spread may not move as far as currently implied by the respective central bank projections, the direction of travel should still be one that points to AUD/NZD moving higher over future quarters.
Currency Strategist - APAC