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Upgrading Our AUD And NZD Forecasts

Fuseworks Media
Fuseworks Media
Upgrading Our AUD And NZD Forecasts

Australian Dollar The AUD surged ahead in the last week, gaining simultaneously against all the major currencies (JPY, EUR, USD and CAD) for the first time in months.

Another unexpectedly strong GDP outcome (+0.6%/qtr for June qtr), overwhelming appetite for risk (in equities, foreign exchange and the AUD bond market) and a general distaste for holding USD has pushed the AUD to fresh 2009 record highs. Indeed, by breaching the $US0.86 level earlier this week, the currency is back to pre-Lehmann-crisis levels of a year ago, and all signs suggest that it is heading higher.

The impetus behind the rally is likely to remain in play for the next few months: a heady mixture of equity-led appetite for risk overlaying solid economic outperformance. Even if we question some of the robustness of recent outcomes (fiscal policy-assisted GDP growth, improved business sentiment despite crumbling sub-components) the market is convinced that Australia has skated through the global recession unscathed.

On average in recent weeks, there are two 25bp RBA rate hikes priced in by year end, and a whopping 175-200bp priced by this time next year. Even if there are some bouts of pull-back on "soft" data, all the signs remain AUD supportive.

While there is no doubt that the RBA tightening cycle will commence shortly - the Bank will decide on timing, not the OIS market - combined with still-thriving investor appetite for risk, we have lifted our year-end AUD target to $US0.88. While appearing conservative compared with the spot rate, we cannot rule out substantial spikes higher - revisiting mid-2008 highs of $US0.95 - on a day of strong data, strong equity markets and ongoing talk of the USD being replaced as a reserve currency.

We are hearing that many real money investors have missed out, and are keep to "buy on dips". In tandem, fresh investors, looking to diversify away from the USD, are also looking at the AUD.

While we are bullish near-term, we remain of the view of the AUD experiencing a material loss of momentum next year as the global cyclical upswing prompts the normalization of global cash rates, slowly eroding the competitive yield advantage. We target $US0.78 by the end of next year.

Looking ahead, once today's employment market has been digested, the highlight next week will be ploughing through RBA entrails via the surprisingly "we are neutral" 1 Sept RBA Board meeting minutes.

These minutes are likely to be AUD positive as we believe the RBA will likely re-iterate that the extraordinarily low cash rate is no longer appropriate - indeed the markets will be looking closely for the terminology that there is currently an "emergency" cash rate in place, and that the emergency no longer exists.

New Zealand Dollar Riding on the coattails of the bullish AUD, the NZD also outperformed the majors in the past week: up 3.4% against the USD; 3.6% against the JPY and 1.9% against the EUR. Steady against the AUD.

Similar to Australia, ongoing near-term risk appetite and globally attractive yields continue to underpin the NZD, hence we have lifted our near-term target to $US0.68, and to $US0.66 by year end.

This is a clear underperformance to the new bullish AUD forecasts as we expect the RBNZ to remain dovish compared with the more aggressive RBA across the Tasman. Indeed, the RBNZ has been very vocal about not lifting the cash rate until well into 2010.

As we have been saying for some time, on a structural basis we do not prefer the NZD given the economy's heavy reliance on offshore capital funding.

While easily funded in the current environment, hence supporting the NZD, we suspect that this outsized reliance on capital will persist beyond the current global appetite for risk and yield.

We expect these structurally weaker fundamentals to come into play next year when the world recovers and New Zealand stalls, and New Zealand's yield advantage is slowly eroded as global yields rise. We target $US0.60 by the end of next year.

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