Tag Archive | "Australian Dollar"

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Dollar Gains After Financial Shares Lag


In a volatile day for currency markets, the USD made headway against the euro, yen, GBP, Aussie dollar and Loonie. Helped by more positive economic data, the dollar rebounded during the day after losing ground against the euro and yen in early trading. The dollar halted its assault at $110 vs. the Canadian dollar and posted significant gains aga8inst the Australian dollar.

Factory output and employment gained momentum according to data from the Mid-West Atlantic region and the Philadelphia Federal Reserve Bank. The data suggests stronger than expected employment in the sector in the two regions which include states of Ohio, Pennsylvania, New Jersey and others. The Philadelphia Fed said its business activity index climbed 9.4 points this month from 6.4 percent in December. This marks a significant gain that would help to counter last month’s disappointing non-farm payroll report.

Bolstering the manufacturing data was a report from the US Labor Department showing that state unemployment benefits dipped by about 2,000 claims to a seasonally adjusted rate of 326,000. The combination of these reports will test the accuracy of the Labor Department’s December payroll report.

The data struggled against early morning returns from Goldman Sachs, Citigroup, two companies that were burned by bond trades in the fourth quarter. Goldman stock was a big loser on the day, falling 21 percent at one point. Citigroup shares turned down 4.1 percent and the S&P financial sector index lost 0.7 percent. The news caught investors by surprise in the wake of positive gains posted by JP Morgan Chase, Wells Fargo and Bank of American on Wednesday.

The DOWD was off 76.53 by mid-afternoon. The S&P 500 lost 4.2 po0its to 1,844.18 as the NASDAQ posted slight gains.

Helping the dollar was continues encouraging data regarding inflation. The December Consumer Price Index rose just 0.3 percent after being flat in November.

Bank of England Currency Rate Scandal

 In information released through freedom of information releases, Reuters reported that The Bank of England discussed their processes for setting foreign exchange rates one ear before the manipulation occurred.

Minutes from the April 23, 2012, meeting of the subgroup of the London Foreign Exchange Joint Standing Committee revealed discussions around fixes, the daily setting of benchmark exchange rates. At the meeting, revelations about online chatrooms that discussing advance notice of the daily settings was revealed. The subgroup met at the London offices of BNP Paribas.

The Financial Conduct Authority, the regulatory wing of the Britain, reported that the BoE only became aware of the irregularities months after the April, 2012, meeting. It was action by the US Department of Justice that forced the investigation into the $5.3 trillion-a-day market in October 2013. Large penalties, fines and legal action are expected.

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Australian Dollar Remains Weak Despite RBA Decision


It was as expected.  The Reserve Bank of Australia left benchmark rates unchanged at 3.25% – compared with some analysts calling for an unexpected rate reduction of another 25 basis points.  As such, the Australian dollar bounced a bit following the release, jumping higher from a six week low against the US dollar.  But, the currency continues to remain depressed in afternoon trading, leaving some scratching their heads.  Here’s why.

On the heels of the announcement, Reserve Bank of Australia Governor Glenn Stevens noted that economic growth in the country’s largest trade partner continues to remain “uncertain”.  Although the Chinese economy “remained reasonably robust in the first half of the year”, the current pace of expansion remains below trend.  In short, the  anticipated weaker pace of growth, or contraction, in China will continue to weigh on future prospects of Australian expansion.  Stevens also noted that thinner demand in Chinese and international markets have depressed prices of iron ore and other commodities that are key to the country’s growth.  Ultimately, the combined decline in commodity prices and future export business will lessen the likelihood that rates will rise, in the near term.

The sentiment has been evident in the increase of bets that the RBA will be forced to reduce rates yet again before the end of the year.  Probabilities are now in the 80% range for another 50 basis points to be cut from the benchmark rate in the next 3 months.

And, as always, Europe remains a constant reminder of global weakness amidst any spate of Australian dollar momentum.  With the week being chock full of short term event risk, there is a dearth of any real Aussie buyers.  This is especially true ahead of the ECB’s interest rate meeting set for later this week.

The sentiment will continue to weigh on the major currency and extend until September 12th, when both the Dutch popular and German Constitutional Court votes are scheduled.  Until then, it may be a slow and agonizing decline before any formidable support can be obtained in the AUDUSD currency pair.

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AUDUSD, USDCAD Dip On Commodity Declines


Commodity currency declines were visible on the first trading of the new week, mostly propelled by dips in the correlated commodities markets.  With risk aversion spreading on the heels that the current Greek bailout talks have stalled – mostly on the part of Greek leaders unable to come to a formidable agreement – major commodities like gold and oil are being sold off.  Gold prices have dipped to $1,724 – down almost 1% on the day.  Crude oil futures haven’t done that much better – falling by 1% to $96.87.

The declines are widely speculated as a normal correction.  In particular, gold was due for a mild correction as the commodity rallied wholeheartedly by 5.5% since the Federal Reserve commitment for looser monetary policy.  The selloff has some technicians eyeing the next round of support which is expected to loom over the $1,700 figure in the short term.

Nonetheless, the commodity declines are forcing both the Australian and Canadian dollars lower against the greenback.  At midday in New York, the Australian dollar is trading at 1.0733, down by 0.16% – and falling from key resistance at the 1.0800 short term technical barrier.  Canadian dollar losses have been approximately on par with the Aussie, falling by 0.16% against the US dollar.  The loonie currently trades at an exchange rate of 0.9960.

Tonight’s central bank decision by the RBA is adding to the overall sell sentiment – with many traders in the market expecting a rate cut of 25 basis points.  The sentiment has been heightened – increasing the probability of a cut a bit over the 50% mark – following worse than anticipated retail sales figures in the overnight.

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Euro On Rise?


Despite the Obama Administration’s resistance to contributing funds to the IMF in support of the euro zone, the euro has gained some traction.  The currency has climbed well above the $1.26 trough and is flirting to move past the current the $1.2867 level.  Traders suggested that the euro remains volatile and the currency may not have bottomed yet.

In October, the euro rose to $1.3145 against the dollar.  Analysts believe that until the currency crosses that threshold the bottom has not been found. 

The Thursday bond sales in France and Spain will serve as a good barometer for how much the S&P downgrades have hurt the euro zone.  Investors are cautiously optimistic in the wake of a bond sale in Portugal that sold 2.5 billion euros in debt and was fully subscribed.  Germany’s Wednesday auction also had more demand than anticipated.

Since last Friday, the dollar index has fallen from 81.784 to a two-week low of 80.473.  The Australian dollar gained strength climbing to an 11-week high of $1.0419. The Australian dollar is holding well above its 200-day moving average.  Australia is believed to have added 10,000 in December.

The Dow Jones equities continue to holdover 12,500.  Much of that support is the result of better banking news than expected.  The major financials appear to have fared better in the 4th quarter and will not require additional capital.

The positive euro zone activity seems foolhardy.  Greece is meting with private investors on Thursday in a last gasp effort to gain approval for their debt swap program, which is little more than a restructured default.

The structured default must occur by week’s end to avoid a breech in the 13.4 billion euro call in March.  Another major problem looms.  There is doubt that investors and hedge funds burned by Greece will stay out of the European bond sale market.  U.S. equities are strong and the dividends are especially appealing.

Treasury Secretary, Tim Geithner, informed the IMF that Europe would have to solve their own problems. U.S. taxpayers cannot come to the aid of countries like Greece, Italy and Spain.  The people lack the will and are clearly supportive of more aggressive jobs legislation.  The political fallout from a bailout of Europe would be devastating to President Obama. 

On the other hand, the European banking sector fell 32 percent in 2011.  Even with a temporary rescue plan, Greece will continue to need funding and Euro Zone members will face this same crisis sooner rather than later.  It is time for private investors to take what little money they can and let Greece go its own way. The negotiations with private investors are tense and it is difficult to see why hedge funds and other investors would throw good money after bad.  That is a business model that is fine with Greece but has no appeal to larger markets.

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Global Markets Volatile


As concerns of a double dip recession in the U.S. and Europe rise, equity, forex and commodity marketplaces are experiencing violent swings.  In the U.S. the Dow Jones fell by more than 400 points on Thursday.  European and Asian equities fell sharply in overnight trading.

The hits just keep on coming from New York to Tokyo.  In the wake of an August 27th meeting of Central Bankers at Jackson Hole, Wyoming, markets are waiting for optimistic news that will most likely not be forthcoming.  The hopes for a successful summit were dashed today on news that China’s Central Bank Governor Zhou Xiaochuan will not be in attendance and nor will any of his senior officials.  In a marketplace grasping for straws, the Jackson Hole Conference, organized by the Kansas City fed, has much of its luster diminished by China’s refusal to attend.

The weak projections of U.S. companies and the political gridlock in Washington have sent the U.S. dollar spiraling down.  The dollar appears headed for parity against the Australian dollar and is giving ground to the euro.  The dollar hit its lowest mark against the yen.

An announcement by Hewlett Packard that it had missed its marks by dramatic margins appeared to hit the equity market hard.  Analysts project major employment cutbacks and a reshaped business plan.

U.S.10-year bonds were trading at 2.10 percent and buyers rushed to gold.  By midday, gold was up about $30.00 an ounce and topped the $1,850 mark.  In a startling poll by the NY Times and CBS, 47 percent of Americans said the safest place for their money was “under the mattress.”

With the President and House of Representatives on their vacations, no legislation to deal with unemployment is on the table.  President Obama has promised a comprehensive jobs program and a spending program upon his return in September.

The President’s proposals will probably resonate with the American taxpayer but may not get out of the House.  Obama’s strategy may well be to put his plan on the table and let taxpayers see how their representatives will vote.

In several town hall meetings this week, Congressmen have been hammered by local constituents.  At times, the attendees at these meetings have turned loudly on their Washington representatives.  The question that remains is whether Washington is listening or not.

The Republicans have selected their mandate that President Obama will not serve a second term.  Taxpayers are less concerned with the Presidency than they are with their own survival.  When Tea Party advocates Eric Cantor and Michelle Backmann threaten to cease unemployment benefits but fight to protect big business, what taxpayers really fear is that the air of intransigence and gridlock will somehow spike higher in September.

 What the country needs is a massive jobs program that gets Americans back to work and makes the nation’s infrastructure stronger.  It has been suggested that Obama’s plan will outline specific spending cuts that will fund infrastructure projects.

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Tide is Turning for the Aussie


“Australia is about to enter a boom that should last decades…The Australian dollar is unlikely to go back to where it was, and manufacturing will shrink in importance to the economy, perhaps even faster than it has been.” This, according to Martin Parkinson, Treasury Minister of Australia. While 30 years from now, Mr. Parkinson’s prognosis might probe to be accurate, I’m not so sure it applies to the period 3 months from now. Here’s why:

First of all, the putative economic boom that is taking place in Australia is being driven entirely by high commodity prices and surging production and exports. Since peaking at the end of April, commodity prices have fallen mightily. You can see from the chart above that there continues to exist a tight correlation between the AUD/USD and commodities prices. As commodities prices have fallen over the last two months, so has the Australian Dollar.


In addition, while demand will probably remain strong over the long-term, it may very well slacken over the short-term, due to declining economic growth across the industrialized world.  Consider also that Australia’s largest market for commodity exports – China – may have difficulty sustaining a GDP growth rate of 10%, and at the very least, new fixed-asset investment (which necessitates demand for raw materials) will temporarily peak in the immediate future.

Finally, the mining sector directly accounts for only 8% of Australia’s economy, which means that only to a limited extent to high commodities prices contribute to the bottom line of Australian GDP. This notion is reinforced by the 1.2% economic contraction in the second quarter – the biggest decline in 20 years – and the fact that GDP is basically flat over the last three quarters. Many non-mining economic indicators are sagging, and the number of corporate bankruptcies is 10% higher than in 2010. In the end, then, the ebb and flow of Australia’s fortune depends less on commodities, and more on other sectors.


Mr. Parkinson’s optimistic forecasts might also be undermined in the short-term by a looser-than-expected monetary policy. The Reserve Bank of Australia last hiked its benchmark interest rate in November 2010, and may not hike again for a few more months due to moderating economic growth and proportionally moderate inflation. Given that an attractive interest rate differential may be driving some of the speculative activity that has girded the Aussie’s rise, a decline in this differential could likewise propel it downward.

That’s because anecdotal reports suggest that the Australian Dollar remains a popular long currency for carry traders, funded by shorting the US Dollar, and to a lesser extent, Japanese Yen. Given that many of these carry trades are heavily leveraged, it wouldn’t take much to trigger a short squeeze and a rapid decline in the AUD/USD. For evidence of this phenomenon, one has to look no further back than May 2010, when the Aussie fell 10-15% in only three weeks.


Ultimately, as one commentator recently pointed out, the Aussie’s 70% rise since 2008 might better be seen as US Dollar weakness (which also catalyzed the rise in commodity prices). The apparent stabilizing of the dollar, then, might let some air out of the currency down under.

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How to Trade the Franc-Yen-Dollar Correlation


Last week, the Wall Street Journal published an article entitled, “Currency Correlations Lose Their Way for Now.” My response: It depends on which currencies you’re looking at. I, too, recently posted about the break-down of multi-year correlations, specifically involving the Australian Dollar and the New Zealand Dollar. However, one has to look no further than the Swiss Franc to see that in fact currency correlations are not only extant, but flourishing!

I stumbled upon this correlation inadvertently, with the intention (call it a twisted hobby…) of refuting the crux of the WSJ article, which is that “Standard relationships between risk appetite and safe havens, and yields and risky assets, are lost as investors appear to scramble in their efforts to adapt to a new direction.” Basically, the author asserted that forex traders are searching for guidance amidst conflicting signals, but this has caused the three traditional safe haven currencies to behave erratically: apparently, the Franc has soared, the Yen has crashed, and the US Dollar has stagnated.


I pulled up a one-year chart of the CHFUSD and the CHFJPY in order to confirm that this was indeed the case. As you can see from the chart above, it most certainly is not. With scant exception, the Swiss Franc’s rise against both the US Dollar and the Japanese Yen has been both consistent and dependable. The only reason that there is any gap between the two pairs is because the Yen has outperformed the dollar over the same time period. If you shorten the time frame to six months or less, the two pairs come very close to complete convergence.

In order to provide more support for this observation, I turned to the currency correlations page of Mataf.net (the founder of which I interviewed only last month). Sure enough, there is a current weekly correlation of 93% [it is displayed as negative below because of the way the currencies are ordered] between the CHFUSD and the CHFJPY, which is to say that the two are almost perfectly correlated. (Incidentally, the correlation coefficient between the USDCHF and the USDJPY is a solid 81%, which shows that relative to the Dollar, the Yen and Franc are highly correlated). Moreover, if Mataf.net offered correlation data based on monthly fluctuations, my guess it that the correlations would be even tighter. In any event, you can see from the chart that even the weekly correlation has been quite strong for most of the weeks over the last year.


The first question most traders will invariably ask is, “Why is this the case?” What is causing this correlation? In a nutshell, the answer is that the WSJ is wrong. As I wrote last month, the safe haven trade is alive and well. Otherwise, why would two currencies as disparate as the Franc and the Yen (whose economic, fiscal, and monetary situations couldn’t be more different) be moving in tandem? The fact that they are highly correlated shows that regardless of whether they are rising or falling is less noteworthy than the fact that they tend to rise and fall together. Generally speaking, when there is aversion to risk, both rise. When there is appetite for risk, they both fall.

The superseding question is, “What should I do with this information?” Here’s an idea: how about using this correlation for diversification purposes? In other words, if you were to make a bet on risk aversion, for example, why not sell both the USDJPY as well as the USDCHF? In this way, you can trade this idea without putting all of your eggs in one basket. If risk aversion picks up, but Japan defaults on its debt (an extreme possibility, but you see my point), you would certainly do better than if you had only sold the USDJPY. The same goes for making a bet on the Franc. Whether you believe it will continue rising or instead suffer a correction, you can limit your exposure to counter currency (i.e. the dollar and yen) risk by trading two (or more) correlated pairs simultaneously.

In the end, just knowing that the correlation exists is often enough because of what it tells you about the mindset of investors.  In this case, it is just more proof that they remain heavily fixated on the idea of risk.

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Aussie is Breaking Away from Kiwi


The correlation between the Australian Dollar and New Zealand Dollar is among the strongest that exists between two currencies. Given their regional bond and similar dependence on commodities to drive economic growth, perhaps this is no wonder. Over the last year, however, the Aussie has slowly broken away from the Kiwi. While the correlation between the two remains strong, the emergence of distinct narratives has given rise to a clear chasm, which can be seen in the chart below. Given that the NZD is evidently among the most overvalued currencies in the world, does that mean the same can be said about the AUD?

Alas, geographic proximity aside, the two economies have very little in common. Australia is rich in coal, precious metals and other natural resources , while New Zealand produces and export primarily agricultural products. Granted, the prices for both types of commodities have exploded over the last decade (and especially the last year), but let’s be clear about the distinction. This has enabled both economies to achieve trade surpluses, but oddly current account deficits. Australia’s economy is projected to grow by more than 4% in 2011, compared to 2% in New Zealand. Australia’s benchmark interest rate is also higher, its capital markets are deeper, and the supply of its currency necessarily exceeds that of New Zealand.

Taken at face value, then, it would seem commonsensical that the Aussie should rise both against the Kiwi and the US Dollar. Indeed, it recently touched an all-time high against the latter, and is now firmly entrenched above parity. On a trade-weighted basis, it has been among the world’s best performers over the last two years.

In fact, some are wondering (myself included), whether the Australian Dollar might have risen too much for its own good. According to OECD valuations based on purchasing power parity (ppp), the Aussie is now 38% overvalued against the dollar, behind only the Swiss Franc and Norwegian Krone. In fact, exporters of non-commodity products (i.e. those whose customers are actually price-sensitive) have warned of mounting competitive pressures, declining sales, and inevitable price cuts. In other words, the portion of the Australian economy that doesn’t deal in commodities is actually in quite fragile shape. Given that China’s economy is projected to slow over the next two years and that booming investment in Australia’s mining sector should boost output, the commodity sector of the economy might soon face similar pressures.

For that reason, the Reserve Bank of Australia (RBA) has avoided raising its benchmark interest rate is fast as some analysts had expected, and inflation hawks had hoped. There is a chance for a 25 basis point hike as soon as June – bring the base rate to an even 5% – but the RBA’s own statements indicate that it probably won’t be until June and July. Regardless of when the RBA tightens, Australian interest rate differentials will remain strong for the foreseeable future, and likely continue to attract speculative inflows for as long as risk appetite remains strong.

So why does the Australian dollar continue to rise? It might have something to do with gold. As you can see from the chart above, the correlation between the Aussie and gold prices is almost just as strong as the relationship between the Aussie and the Kiwi. Given that Australia is the world’s second largest gold exporter, it is perhaps unsurprising that investors would see rising gold prices as a reason for buying the Australian dollar. However, it seems equally possible that demand for both is being driven by the pickup in risk appetite. While some gold buyers might counter that gold is best suited for those who are averse to risk (i.e. afraid that the financial system will collapse), the performance of gold over the last five years suggests that in fact the opposite is true. When risk appetite is high, speculators have bought gold and the Australian dollar (among other assets).

It’s unclear whether this will remain the case going forward. The Wall Street Journal recently reported that gold is increasing attracting risk-averse investment, as buyers fret about the eurozone sovereign debt crisis and other threats to the system. However, the same cannot be said about the Australian Dollar. For as long as risk is “on,” demand for the Aussie will remain intact. And if the Aussie Dollar Barometer survey – which found that “exporters expect the Australian dollar to reach a post-float record of $US1.16 by September and to remain above parity well into next year” – is any indication, risk appetite will indeed remain strong for the foreseeable future.

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The Euro (Still) has a Greek Problem


Since the beginning of May, the euro has fallen by a whopping 7% against the dollar on the basis of renewed fiscal uncertainty in the peripheral eurozone. The optimists would have you believe that the markets will soon forget about the so-called sovereign debt crisis and just as quickly return their focus to monetary policy and other euro drivers. Personally, I think investors to follow such a course, as forex markets must eventually reckon with the seriousness of the eurozone’s fiscal troubles.

First, I want to at least acknowledge the primary sources of euro support. Namely, the European Central Bank (ECB) recently became the first “G4″ central bank to raise its benchmark interest rate; at 1.25%, it is now the highest among major currencies, save only the Australian dollar. Moreover, there is reason to believe that the ECB will hike further over the coming six – twelve months. First of all, eurozone price inflation continues to rise, and the ECB is notoriously hawkish when it comes to ensuring price stability. Second, Q1 GDP growth for the eurozone was a solid .8%, thanks to especially strong performances from France and Germany. While the ECB will likely follow the lead of the Bank of England and wait until Q2 data is released before making a decision, the strong Q1 performance is nonetheless an indication that the eurozone can withstand further rate hikes. Finally, Mario Draghi, who has been confirmed to replace Jean-Claude Trichet in June as head of the ECB, will need to effect an immediate rate hike if he is to establish credibility with the markets.

As I wrote in my last euro update (“Time to Short the Euro“), however, such a modest ECB interest rate – regardless of how it compares to other G4 rates – should hardly be enough to compensate yield-seekers for the risks associated with holding the euro for an extended period of time. Of course, the primary risk I am talking about is the possibility first of a full-fledged sovereign debt crisis, and secondarily of a eurozone banking crisis.

At this point, it is painfully obvious to everyone except for EU officials that the status quo cannot continue. Bailout funds cannot be expanded and rolled over indefinitely, especially since 3 countries (Greece, Ireland, and Portugal) are now involved. Greece, which is certainly the most pressing case, faces skyrocketing interest rates and declining interest from creditors, even as its budget deficit and national debt rise and its economy shrinks. Under these conditions, there is no way that it can re-enter private bond markets in 2012 (as was originally expected), if at all.

Thus, the only question is, what will happen instead? If Greece were to leave the eurozone, it could inflate away its debt, devalue its currency, and decrease interest rates. Regardless of its merit, this possibility has been vehemently dismissed because of concerns that it would lead to the implosion of the euro, and it seems very unlikely. What if Greece were to restructure its debt, by demanding concessions from bondholders? Based on the bond covenants, it apparently has wide latitude to do so, and might not even face legal repercussions. This possibility is also opposed by the ECB and EU officials because it would force banks to take massive [see chart below] write-downs on their debt holdings.

Greece could similarly elect to “re-profile”- basically lengthening the bond maturities (no “haircut” on interest and principal), ostensibly to give it more time to retool economically and fiscally. While this is a popular option, it probably would only succeed in forestalling the inevitable. Finally, the EU (with help from the IMF) could continue to loan money to Greece, in exchange for more additional austerity measures and collateralized by sales of state assets. Alas, this would be met with stiff political resistance from Greece. Not to mention that the recent indictment of Dominique Strauss-Khan – head of the IMF- on rape charges has jeopardized what has been the highest-profile advocate for continued support of Greece.

It seems inevitable that Greece will default on all or part of its debt. That’s not to say that this would cause its economy to collapse, nor that it would precipitate the end of the euro. In fact, recent history is full of cases of countries that successfully declared bankruptcy and emerged several years later unscathed. In this way, Greece could probably eliminate half of its debt, and significantly ease the burden that it poses.

Of course, this would not only set a dangerous precedent for Ireland, Portugal (and perhaps even Spain and Italy), but it would also reverberate throughout Europe’s banking sector, and would probably necessitate multiple bailouts. But what’s the alternative? Dragging out the crisis with secret meanings and feckless proposals will only add to the uncertainty. If Greece and the rest of the eurozone can come to grips with its collective fiscal problem, it will certainly cause chaos in the short-term and a further decline in the euro. By removing uncertainty, however, it will buttress the euro over the long-term and allow it to remain in existence.

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Is the Kiwi the Most Overvalued Currency?


During recent interviews with the Forex Blog, both Mike Kulej of FX Madness and the team at Action Forex imparted their beliefs that the New Zealand Dollar is currently the world’s most undervalued currency. Since I hadn’t written about the Kiwi in a few months, I decide to some research, ad came to a slightly different conclusion. In keeping with the spirit of debate, I’d like to defend the opposite premise- that the New Zealand Dollar is now one of the world’s most overvalued currencies.

There are two principal reasons for the Kiwi’s perennial appeal with forex traders. First, New Zealand frequently boasts some of the highest interest rates in the industrialized world. Before the credit bubble burst, New Zealand’s benchmark interest rate was a whopping 8.25%. Moreover, because of its association with Australia, investors are quick to ascribe to it (dubiously) a greater sense of security than they would to emerging market economies with similarly high interest rates. For example, while Brazilian rates are usually higher, the markets less apt to lump the Real together with the Australian Dollar, even though it’s arguably a closer fit than the Kiwi.

While it’s hard to predict New Zealand trade dynamics, we can say with relative certainty real interest rate levels will remain low for the foreseeable future. Two recent earthquakes have threatened an economy that is already in trouble (projected GDP growth in 2011 is only 1.3%). Over the next 12 months, the markets have priced in only 50 basis points in rate hikes. “Nothing here will change the RBNZ’s intentions to keep monetary policy at ‘emergency’ levels for the rest of this year,” summarized one analyst. Meanwhile, the CPI rate is currently at 4.5%, and is generally tracking commodities prices higher.

Thus, it is continually one of the most popular target currencies for carry trades. The extent of this phenomenon is such that turnover in the Kiwi is 100x greater than its GDP would imply. As I pointed out in an earlier post, this is the highest ratio of any currency in the world. In fact, “Dr Alan Bollard, Governor of the Reserve Bank [of New Zealand], once described it as an international standard of value that just happens to be used by a small country as its money.”

The credit crisis should have shattered the myth of the NZD as a stable currency, since the NZD lost 50% of its value in a matter of months. In addition, the benchmark rate has been lowered to 2.5%, a record low. When you take inflation into account, the rate is -2%, which as far as I know, is among the lowest in the world. When you factor in consecutive budget deficits for the first time in two decades and the (unrelated) explosion in public debt, it baffles me that yield seekers would still be interested in holding the Kiwi.

The other source of strength is the perception that the Kiwi is a commodity currency. To be fair, the production and export of agricultural products (dairy, meat, wool, etc.) makes a significant contribution to New Zealand’s economy. In addition, the prices for such agricultural staples have been rising faster than prices for imported goods, to the extent that the terms of trade have widened further in New Zealand’s favor. Unfortunately, this is ultimately irrelevant, since the aggregate balance of trade is currently in deficit, where it has stood for most of the last decade. If prices for energy and traditional commodities continues to rise, the current account deficit would at risk for eclipsing the record 6% set in 2008.

With all of this in mind, it’s tough to understand how the New Zealand Dollar could be closing in on a post-float (30 year) high against the Dollar, last set in 2008. The New Zealand Dollar has recovered most of its post-credit crisis losses, despite a lack of fundamental support. Its recovery has even outpaced the rise in the New Zealand stock market. In short, I’m inclined to agree with TD Securities: ” ‘If ever there was a dangerous time to enter a NZD carry trade this is it: the NZD is increasingly stretched, with the risk-reward now squarely being the NZD declining from here’…if the NZD breaches prior record highs, ‘it could be an attractive time to trim some net longs.’ ”

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