AUD/NZD: Contrasting trends and policy uncertainties – BNY

Australian Dollar Outperforms as New Zealand Dollar Faces Challenges

Bob Savage, who leads Markets Macro Strategy at BNY, observes a widening gap between the Australian Dollar (AUD) and the New Zealand Dollar (NZD). Investors are showing a preference for currencies supported by tangible assets. Although New Zealand's commodity prices remain robust, the NZD is not attracting significant capital flows. In contrast, the AUD is gaining from favorable trade conditions and a decrease in hedging activity. Savage suggests that if this divergence between AUD and NZD starts to affect spot rates, the Reserve Bank of New Zealand (RBNZ) might be compelled to adjust interest rates in response.

Market Flows Shift Toward AUD

While, in principle, the NZD could benefit from rising soft commodity prices, current market flows do not reflect this potential. Factors such as energy and fuel costs are influencing New Zealand’s balance of payments, and the NZD lacks the attractive nominal and real interest rates needed to draw in foreign investment.

There are concerns that the RBNZ may not be able to act decisively enough in the face of inflation risks, which were already present before recent developments. At the moment, market participants are showing limited enthusiasm for the NZD, whereas the AUD is attracting more attention.

Historically, both the AUD and NZD have been relatively stable in terms of cross-border holdings. However, since early February, the two currencies have diverged, with a 40 percentage point spread now evident when comparing their current holdings to their respective 12-month averages.

The AUD/NZD exchange rate plays a significant role in New Zealand’s trade-weighted currency indices, and substantial shifts could influence the inflation outlook for tradable goods.

Institutional investors have notably reduced their AUD hedges while increasing their NZD positions. This shift has been driven by differences in monetary policy communication, as well as Australia’s greater ability to benefit from positive terms-of-trade shocks related to both hard and soft commodities.

Currently, the market is focused on increasing exposure to only one of these currencies, with the AUD being the clear choice. Should the divergence between the two currencies begin to significantly impact spot prices, the RBNZ may be prompted to consider changes to interest rates as a response.

(This report was produced with the assistance of artificial intelligence and reviewed by editorial staff.)