New Zealand Dollar Strength May Continue With A Potential RBNZ Rate Hike Looming.

NZD/USD

The New Zealand dollar has tracked commodity prices and equity markets which continue to rise on signs that a global recovery is under way. The Reuters-Jeffries/CRB Index which is made up of nineteen different commodities is currently explaining 57% of NZD/USD volatility. Its influence has grown over the past month as demand for risky assets continues to gain momentum despite remaining downside risks. RBNZ interest rates expectations have also soared and surprisingly beginning to outpace the local currency, which has diminished its influence on price direction to 17% from 24% last week.  The RBNZ will meet next week to set their target rate with median forecasts for the central bank to remain on hold. A surprise rate hike from the central bank should spark bullish Kiwi sentiment which would increase yield expectations impact on price action going forward.

RBNZ Interest Rate Expectations

Overnight index swaps are now pricing in 211 bps of rate hikes from the RBNZ in the next twelve months. Interest rate expectations have skyrocketed since the RBA surprise markets by raising their target rate and hinted at future tightening. Although, the New Zealand economy is expected to receive the same benefits as its antipode cousin from Chinese growth, its economy has similar characteristics. Therefore, if policy makers view the same risk to inflation then they could follow suit with their own rate hike which should send the Kiwi higher.

FOMC Interest Rate Expectations

Fed funds futures are currently pricing in a 6.4% chance of a rate hike by the end of the year which is down from 6.6% a week ago. The FOMC minutes following the central bank’s last rate decision stated that they intended to keep rates on hold for the foreseeable future. Until the threat of tightening becomes real, U.S. yield expectations will continue to have little influence over the NZD/USD’s price action. However, upcoming U.S. third quarter GDP figures are forecasted to show a 3.1% surge in growth which could accelerate the timetable for rate hikes from the Fed.

Commodities

Commodity prices typically lag equity markets but we are seeing them in lock step which has many experts predicting that they will only go higher from here as growth returns. As China’s and India’s economies expand their thirst for natural resources will follow and until output can catch up prices should continue to rise. The RJ/CRB index is currently trading above its ten year average of 270 but is still far from the all-time high of 473 set in July, 2008. However, the New Zealand economy doesn’t produce oil at the level of its com-dollar counter parts Canada and Australia which may see its correlation to the broader index wane if crude costs outpace other index components.

To discuss this report or be added to the email list contact John Rivera, Currency Analyst: jrivera@fxcm.com