Don’t get burned twice on AUD and NZD

AUDUSD and NZDUSD have fully recovered from the 10% to 15% August sell-off of high-yielding currencies. The trigger for this recovery has been broad USD weakness and increasing risk appetite. Following the Fed interest rate cut of 50bp, investors are focusing again on return. As a consequence, implied volatility in these currency pairs has fallen. This makes risk-adjusted interest rates differentials, which speak in favor of AUD and NZD, attractive again, according to the latest edition of UBS Investors’ guide.

From a fundamental perspective, both AUD and NZD are overvalued. UBS analysts believe that these currencies will remain overvalued for a prolonged period, especially with markets calming down after the recent worries about the US housing market. The question is: how much overvaluation is justified by elevated commodity prices? Overall, commodity prices look set to remain high; yet base metal prices are falling, which is negative for Australia. Both Australia and New Zealand export agricultural goods, and due to ongoing food price inflation in Asia and drought-induced supply shortages, prices are rising. As UBS analysts expect global growth to slow down slightly, commodity prices should trend sideways, giving no further impetus for a higher AUD or NZD.

In terms of interest rates, solid macroeconomic data and future (longer-term) inflation pressure have kept interest rate expectations high. Markets expect the Reserve Bank of Australia to hike interest rates at least one more time by 25bp, while markets also show a positive bias regarding the Reserve Bank of New Zealand’s policy rates.

Both expectations are too aggressive and risk disappointments. If UBS’s view materializes, AUD and NZD should weaken. Dominic Schnider, an analyst at UBS advises exiting AUD and NZD long positions, and sees the USD as an attractive alternative. At AUDUSD 0.825 and NZDUSD 0.71, new AUD and NZD positions look attractive again. Investor preferring high-yielding currencies are advised to hold NZD positions. Rising food prices are more supportive for the NZD than for the AUD in the short run.