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New Zealand Dollar Likely to Follow Stock Markets Lower

New Zealand Dollar Likely to Follow Stock Markets Lower

2011-05-07 07:43:00
Ilya Spivak, Sr. Currency Strategist
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New_Zealand_Dollar_Likely_to_Follow_Stock_Markets_Lower_body_Picture_3.png, New Zealand Dollar Likely to Follow Stock Markets Lower

Fundamental Forecast for New Zealand Dollar: Bearish

The New Zealand Dollar continues to trade broadly in line with broad-based trends in risk sentiment as prices continue to track the MSCI World Stock Index. On balance, this points toward weakness in the week ahead, albeit not without some choppy trade and probably a handful of false starts.

The spectrum of risky assets tumbled last week. Stocks, key commodities, and high-yielding currencies all came under intense selling pressure while the US Dollar rose 2.7 percent, marking the largest five-day rally in 10 months. The catalyst between the aggressive reversals was almost certainly April’s Federal Reserve monetary policy announcement, where the rate-setting FOMC pledged in no uncertain terms to end quantitative easing (QE) as the controversial program’s second round expires in June. With the Fed thereby in neutral, the direction US yields would be once again left to the markets.

Simply put, the Fed’s action amounted to telling investors that had capitalized on QE to borrow Dollars on the cheap and use them to invest in higher-yielding assets, “From this point forward, you are on your own, and if yields rise then so be it.” Needless to say, the size of the US budget deficit and the amount of new bond issuance that it implies – not to mention the recent S&P downgrade of the US credit outlook – suggests borrowing costs will indeed move higher as bond prices decline once Ben Bernanke and company take to the sidelines.

Presented with such stark reality, investors began to book profits on their Dollar-funded exposure, sending all of the assets that had benefited from the status quo – with the Kiwi Dollar among them – broadly lower while the greenback enjoyed a robust recovery. More of the same is likely ahead as the QE expiry deadline looms ever-closer, although the move will see some fits and starts as bouts of weakness bring buyers eager to capture attractive entry points into what will appear to still be well-established trends. A fundamental shift seems nonetheless underway however, and the environment it is likely to produce is one in which the New Zealand unit finds itself on the defensive.

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