Caution grows over New Zealand dollar's bull run vs Aussie

LONDON/SYDNEY Wed Jan 29, 2014 1:06pm EST

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LONDON/SYDNEY Jan 27 (Reuters) - Hedge funds and currency strategists are growing increasingly cautious over the New Zealand dollar's strength against the Australian dollar, believing its long bull run could finally be nearing an end.

The Aussie slid to an eight-year low of NZ$1.0484 last Friday, its fall having accelerated over the past year as concerns have grown over resource-rich Australia's exposure to a slowing Chinese economy.

Its decline has proved a great trade for hedge funds, who have latched on to the clear downward trend and heeded Australian central bank governor Glenn Stevens's wish for the Aussie to weaken.

But some think the New Zealand dollar's gains may have run their course, with the factors behind its strength largely priced in. These include higher interest rates, which are widely expected, with a minority in markets thinking the Reserve Bank will even begin tightening policy on Thursday.

Ian Gunner, manager at Altana Hard Currency Fund, said the fact that Friday's fall in the Australian dollar-New Zealand dollar rate was followed by a move higher, forming a so-called candle stick on the chart, supported this view.

"It's a warning sign that we're close to an end. It would suggest the beginnings of a reversal," Gunner said. "I'd be very nervous putting on short Aussie-Kiwi."

In a world where ultra-low interest rates have made currency trading very tough, hedge funds have paid particularly close attention to likely interest rate rises in New Zealand's resurgent economy and recent weak Australian economic data.

Markets are pricing in a 40 percent chance that the RBNZ will raise interest rates by 25 basis points from a record low 2.5 percent, although most economists expect the central bank will wait until March before hiking.

Implied rates derived from money markets are pricing in 125 basis points of rate hikes by the RBNZ over the next 12 months . In Australia, where jobs data this month showed a surprise fall in employment, the implied rates are pricing in virtually no change.

But the case for a rebound is building, with Stevens's words having had some success, pushing the Aussie to a 3-1/2-year trough on a trade-weighted basis last week.

Meanwhile, Australia's CPI inflation rose more than expected last week, dealing a major blow to the prospects of another rate cut and supporting the Aussie dollar.

RBC Capital Markets said in a client note on Tuesday it no longer expects the RBA to cut. Instead, it now sees the cash rate staying at a record low into 2015.

Meanwhile, the rate rises implied in New Zealand are seen by some strategists as a tall order and fully priced into the kiwi.

"We think it is very poor risk reward to chase AUD/NZD lower at current levels. The bulk of the move, in our view, has already occurred," said Societe Generale strategist Alvin Tan, highlighting long-term support at the NZ$1.05-6 level.

On Wednesday, the Aussie was 0.4 percent lower at NZ$ 1.0587, with options expiring next week around NZ$1.0638.

Traders are eyeing the December 2005 low of NZ$1.0421, in the belief that the longer it stays away from those levels the greater the chance of a correction.

There are signs that hedge funds have moderated their bets.

Funds cut back their long positions on the New Zealand dollar slightly over the week to Jan. 21 while modestly adding to short positions, according to the CFTC's latest Commitment of Traders report. Meanwhile, long bets on the Aussie were raised at a faster relative pace than short bets.

Simon Smith, FxPro's head of research, says the Aussie could fall to the NZ$1.03-5 range, but not much further.

"A lot is in the price, which is why we'd struggle to go to parity from here," he said. (Additional reporting by Naomi Tajitsu in Wellington; Editing by Catherine Evans)

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