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Australian Dollar May Rise vs. NZD as RBNZ Rate Hike Bets Soften: Q4 Top Trades

Australian Dollar May Rise vs. NZD as RBNZ Rate Hike Bets Soften: Q4 Top Trades

Daniel Dubrovsky, Senior Strategist

Australian Dollar, New Zealand Dollar, AUD/NZD – Q4 Top Trades

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The Australian Dollar had a fairly pitiful third quarter against the New Zealand Dollar. It was for good reason though. The relationship between AUD and NZD can be rather unique. These two currencies are known for their ‘sentiment-linked’ characteristics. In other words, when investors are feeling bullish and pile into risk-oriented assets, both AUD and NZD can capitalize from these flows.

So what then happens when you compare both against each other in AUD/NZD? Well, if both currencies rally with market sentiment, the net effect against each other could leave it little changed. This relationship is not perfect, and volatility is still possible in this pair. What this does mean is that the pair can be more sensitive to relative RBA and RBNZ monetary policy divergences.

This divergence is a reflection of the differences between the economies of Australia and New Zealand. But, given their close trading relationship, it does not seem likely that both countries may deviate far away from each other. This can translate into more persistent range-trading dynamics for AUD/NZD. In fact, since the beginning of 2014, the pair has been doing a lot of range trading.

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What likely allowed AUD/NZD to fall in the third quarter is the surge in New Zealand government bond yields relative to Australia – see chart below. Divergent approaches to Covid containment likely played a key role. Australia’s ‘Covid zero’ approach reduced local growth expectations as the nation enforced lockdowns across the country.

Australia is expected to see GDP growth materially slow in the third quarter, and August’s jobs report saw many citizens exit the labor force altogether. On the plus side, heading into the fourth quarter, the nation is seeing a material pickup in Covid vaccinations. Moreover, the RBA doesn’t expect recent economic weakness to linger, leaving the broader outlook intact.

Meanwhile, the markets risk getting ahead of themselves around the Reserve Bank of New Zealand. According to overnight index swaps, a full 25 basis point rate hike is mostly priced in for October. Looking beyond that, another 100 basis points of tightening is also roughly priced in by August 2022. This leaves the skew biased to the downside for disappointment in a still-uncertain environment.

Markets are forward looking. New Zealand is set course to have a relatively tighter monetary policy than Australia, but the degree of which could still vary as data continues to flow. The central bank withheld raising rates in August amid a Covid outbreak. This could offer a window for AUD/NZD to accelerate higher in the fourth quarter as traders seem at risk of a classic “buy the rumor, sell the facts” outcome.

AUD/NZD Versus Relative Government Bond Yield Spreads

AUD/NZD Versus Relative Government Bond Yield Spreads

Chart Created in TradingView

--- Written by Daniel Dubrovsky, Strategist for DailyFX.com

To contact Daniel, use the comments section below or @ddubrovskyFX on Twitter

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