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Aussie, NZ dollars tested as yield cushions turn threadbare

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The Australian dollar stayed on the defensive on Wednesday as local short-term yields came close to breaking below those in the United Sates for the first time since 2000, undermining the Aussie's attraction as a carry trade.

[WELLINGTON] The Australian dollar stayed on the defensive on Wednesday as local short-term yields came close to breaking below those in the United Sates for the first time since 2000, undermining the Aussie's attraction as a carry trade.

It was was flat at US$0.7579 and within spitting distance of a five-month trough of US$0.7532 hit on Tuesday.

The Aussie had got a slight lift overnight when Reserve Bank of Australia (RBA) Governor Philip Lowe said it more likely the next move in interest rates would be up than down, quashing any idea that recent soft data on wages and inflation might lead to a cut.

Yet Mr Lowe also emphasised that both wages growth and inflation looked set to be lower for longer than first expected, meaning there was no case for a hike either.

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Markets have already pushed out the likely timing of a rate rise, with a move from 1.5 per cent not fully priced in until March of 2019.

"Soft underlying domestic demand, with uncertainty over the outlook for housing, barely within-target inflation, and ongoing excess labour market capacity, points to little reason for the cash rate to move until early 2019," said Su Lin Ong, head of Australian strategy at RBC Capital Markets.

Yet RBC expects the US Federal Reserve to hike by 25 basis points next month and by 100 basis points over 2018, which would take the US cash rate well above that in Australia.

That sea change is being reflected in bond markets with Australian two-year yields now a mere two basis points above their US counterpart, having been as much as 60 basis points higher a couple of months ago.

The last time they broke below US yields was in mid-2000, when the Aussie was hovering around US$0.5900.

Likewise, the spread between New Zealand two-year paper and the US has collapsed to 23 basis points, having been as wide as 76 basis points in September. Kiwi yields have not been under those in the US since the end of 1999.

That compression in spreads coincided with a fall in the kiwi dollar from atop US$0.7300 to as low as US$0.6781 last week.

The slide has, however, left the market very short of the currency allowing a modest bounce in the last couple of days.

On Wednesday, the kiwi was trading up 0.2 per cent at US$0.6843, but faced chart resistance at US$0.6883.

The bounce helped overcome an auction showing prices for dairy, the country's largest export earner, had dropped for the fourth time in a row.

Aiding sentiment locally were figures showing net permanent migration posted yet another strong jump of 5,580 in October.

New Zealand government bonds gained, sending yields three basis points lower at the long end of the curve.

Australian government bond futures were mixed, mirroring a further flattening in the US Treasury curve. The three-year bond contract was flat at 98.060 while the 10-year contract firmed 2.5 ticks to 97.4600.

REUTERS

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