Hedge-fund longs, hawkish rate bets mean NZ dollar has room to fall

Singapore

THERE'S a wealth of positive news out there for the New Zealand dollar. All the more reason it may be poised to weaken.

Leveraged funds' long positions are near a three-year high, while traders are pricing in more than a 90 per cent chance of another central bank interest rate hike in November. With all this good news already in the price, there is plenty of room for disappointment.

There are a number of possible catalysts that may convince the Reserve Bank of New Zealand (RBNZ) to delay its intended interest rate hikes. These include any worsening in the current Covid outbreak or a slowdown in the pace of job creation - both factors it has flagged as possible reasons to delay tightening.

At the same time there is a big underlying negative. The Federal Reserve has reaffirmed its commitment to cut back on bond purchases as it progresses towards normalising policy, which will create a consistent bid for the US dollar.

"We see limited further upside for NZD/USD because interest rate markets are fully pricing an RBNZ rate-hike cycle, while we still see room for US markets to adjust their Fed Funds rate expectations higher," said Kim Mundy, a currency strategist at Commonwealth Bank of Australia in Sydney. In addition, "the prolonged Covid-19 restrictions in New Zealand can weigh on NZD if it causes interest-rate markets to reassess the outlook for RBNZ rate hikes", he said.

Overnight index swap markets are pricing in a 92 per cent chance of a 25 basis-point rate increase at the next RBNZ meeting on Nov 24, and an 86 per cent probability of an additional one at its following gathering in February.

The central bank has a track record of doing the unexpected. It raised its benchmark for the first time in seven years on Oct 6, but only after disappointing hawks that had expected a move in August.

Technical analysis also identifies a challenge. While the kiwi-US dollar exchange rate climbed above 0.70 last week from September's low of 0.6860, it is now approaching resistance at September's high of 0.7170. A failure to breach that level may send it moving lower again.

The kiwi faces a more immediate threat in the form of inflation figures due on Oct 18. Economists surveyed by Bloomberg predict consumer prices probably accelerated to at an annual rate of 4.2 per cent last quarter.

If the reading falls short of that, then more doubts may start to creep in as to whether a November rate hike is really a done deal. BLOOMBERG