NZD outperforms

NZD has been the best performing major currency so far this year outshining other currencies by a wide margin. We expect further NZD/USD appreciation, albeit at a much more gradual pace over the coming months.

The kiwi has been propelled higher by a host of positive economic indicators including jobs data which has revealed an improving trend against the background of strengthening consumer and business confidence.

Economic growth is on track to reach our forecast of 3% this year. Additionally supportive of the NZD is the fact that NZ’s major commodity exports especially dairy products have remained high. NZD will also be helped by a likely healthy reading for Q4 GDP expected to come in at 3.7% YoY on Thursday.

NZD/USD looks set to target the 2013 high of 0.8676 as the next key target, a level that will provide strong resistance.

RBNZ sends a hawkish message

The RBNZ delivered few surprises by raising policy rates by 25bps to 2.75% overnight. The decision was widely expected but nonetheless managed to give further support to the NZD. The kiwi benefitted from a relatively hawkish statement, with the central bank stating that rate hikes totalling 125bps are likely over the coming months while revising higher its growth and inflation forecasts.

Despite some jawboning to talk the NZD lower RBNZ governor Wheeler noted that opportunities for FX intervention were low. Gains in the NZD look impressive given the headwinds from growth worries in China and lower commodity prices but downside risks remain limited, with NZD/USD set to sustain a move above 0.8500 in the near term. Also positive for NZD is the fact that milk prices continue to remain well supported.

Australian dollar rallies, Korean won bounces back

On the currency front, the best performers so far this year have been an odd combination of JPY, NZD and AUD versus USD. JPY has benefitted from both compressed yield differentials with the US and risk aversion but its gains are likely to reverse over the coming weeks as these factors reverse.

I have been generally more constructive on AUD and NZD than the consensus and remain so. Both AUD and NZD look oversold and will gradually appreciate further, especially as both the RBA and RBNZ have now likely ended their easing cycles, with the latter set to raise policy rates by the end of this quarter. AUD/USD breached 0.90 this morning helped by a strong business confidence reading for January.

Most Asian currencies have rebounded so far this month, with some of the biggest losers over January recording gains. The KRW has been the best performer in February recording gains despite continued outflows of equity capital. Korea has recorded $1.26 billion in equity outflows so far this month, the highest among Asian countries.

In contrast bond inflows into Korea have been relatively solid over January and this continued into February, helping to provide some support to KRW despite equity outflows. Helping the KRW is the fact that is much less sensitive to US bond yields than many other Asian currencies helping it to avoid any fallout from higher US yields in February. USD/KRW is on path for a break below support around 1070.

Some respite for emerging market assets

Large gains in many emerging market currencies have been registered in the wake of policy rate hikes in Turkey and to a lesser extent in India. Also some encouraging data in Asia in particular a widening in South Korea’s current account surplus helped to shore up confidence in regional currencies. Not wanting to throw cold water on the move but while everyone is lauding Turkey for its bold move the reality is that its aggressive rate hike will hit growth at a time when its economy is fragile.

The massive rate hike in Turkey (repo rate hiked from 4.5% to 10%) fuelled a bounce in risk appetite nonetheless, although most risk measures have only reversed part of the move registered over recent days. It is way too early to suggest that everything is returning back to normal and the rally in risk assets looks vulnerable to fading out over coming days.

While I am not a proponent of the nervousness in emerging markets turning into a renewed crisis, uncertainty about country specific issues such as slowing growth and deleveraging in China, fundamental and political uncertainties / elections in Thailand, India, Indonesia. Ukraine and countries in the “fragile 5” against the background of Fed tapering, suggest rocky times ahead.

Moreover, the market may have priced in another $10 billion of Fed tapering today but the reality is that the global liquidity injections provided by the Fed will be reduced over coming months. Additionally a likely renewed rise in US Treasury yields will add another layer of pressure on emerging market assets.

Although emerging market currencies have strengthened most G10 currencies remain in a tight range. G10 FX gains were led by the AUD and NZD while JPY came under renewed pressure. This pattern is likely to continue in the near term. Aside from the Fed FOMC there will be some attention on the Reserve Bank of New Zealand too. The RBNZ is expected to keep policy rates unchanged but there is a small chance of rate hike or at the least a hawkish accompanying statement which ought to keep the NZD supported.

Firm US data not helping the dollar

The US November employment report released at the end of last week helped to reinforce expectations that the Fed will begin tapering soon, possibly as early as the FOMC meeting in mid December. Non-farm payrolls rose by 203k while the unemployment rate dropped to 7%. Job gains have averaged around 180k per month over the last 6 months. The jobs data followed on from several other firm US data releases over the week highlighting strengthening signs of recovery.

Equities reacted well, rising as fears over tapering were outweighed by concrete signs of recovery. Meanwhile bond yields rose over the week although they slipped on Friday. Attention will turn to next week’s Fed FOMC meeting while this week’s data flow will be more limited. The main event will be the November US retail sales report where a moderate gain in sales is expected in terms sales outside of autos, providing the final clues to the Fed’s decision next week.

Elsewhere markets are still reeling from the ECB’s less dovish than expected statement last week as reflected in the subsequent strength of the EUR. Data this week in the Eurozone will be encouraging, with Eurozone industrial production set to rebound. This will be echoed in the UK, with hard data reflecting the strength in manufacturing surveys.

In Japan this morning’s data slate was disappointing, with Q3 revised lower and the current account registering a deficit for the second straight month in October although the JPY impact will be limited. Finally, the RNBZ is will hold a policy rate meeting this week although no change is expected from the central bank as recent mortgage restrictions will have reduced the need to tighten policy. Nonetheless, as reflected by the latest NZ housing data loan to value mortgage restrictions have yet to have a significant impact.

The USD failed to benefit from the solid data in the US last week undermined by some slippage in US yields, with the reaction indicative of a market that is becoming increasingly accustomed to the idea of an imminent Fed tapering. The USD index appears to be struggling into year end, with the EUR taking advantage of the USD’s inability to push higher especially given that the ECB did not appear to be in any hurry to add more monetary accommodation last week.

Conversely USD/JPY looks set to continue to edge higher as sentiment for JPY continues to deteriorate; latest IMM positioning data shows that net JPY positions have hit their lowest since July 2007. The next key technical resistance level is around 103.74. Firm trade data in China over the weekend helped to bolster AUD and NZD although the latter is benefitting the most, boosted overnight by strong house price data in November. Consequently AUD/NZD continues top plumb new depths.


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