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NZ dollar may run out of puff as interest rate differential with US narrows

Friday 26th January 2018

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The New Zealand dollar is heading for a 0.9 percent gain against the greenback this week but may run out of steam as investors pay more attention to a narrowing interest rate differential with the US. 

The kiwi rose to 73.38 US cents as at 5pm in Wellington from 72.75 cents on Friday in New York last week, in a volatile week where it soared on jawboning from the US Treasury secretary before slumping on softer-than-expected inflation. The trade-weighted index is heading for a 0.3 percent weekly decline to 74.69 and is down from 75.02 yesterday. 

The local currency has gained 3.5 percent so far this year as heightened political uncertainty has left the greenback out of favour with a brief US federal government shutdown, introduction of trade tariffs and looming debt ceiling. The greenback came under greater scrutiny this week when Treasury Secretary Steven Mnuchin said a weaker currency was good for trade, comments US President Donald Trump today said were taken out of context when advocating a stronger greenback under his administration. Trump's speech to the World Economic Forum in Davos will be a highlight for investors in the Northern Hemisphere session. 

For all that, the US economy continues to report robust growth and corporate tax cuts have underpinned a strong earnings season, helping push stocks on Wall Street to record highs and removing barriers to the Federal Reserve raising interest rates this year. At the same time, New Zealand's Reserve Bank is less likely to lift the official cash rate from its record low 1.75 percent until 2019 after fourth-quarter inflation data this week was well below expectations, prompting two bank economist teams to push out their forecasts for tighter monetary policy. 

"If you're going to have the Federal Reserve still hiking rates and the Reserve Bank on hold, US rates and New Zealand rates are going to get pretty close pretty quickly," said Tim Kelleher, head of institutional foreign exchange sales at ASB Bank. "How is the kiwi dollar going to sustain itself if US rates are higher, there's got to be some risk premium to being long kiwi, surely?" 

ASB's Kelleher said at current levels the kiwi looks like a 'sell' at around 73.50/74.50 US cents over the medium term. 

New Zealand two-year swap rates were unchanged at 2.17 percent, and are down from 2.25 percent at the end of last week, while 10-year swaps fell 2 basis points to 3.21 percent, and are down from 3.28 percent last Friday. 

Kelleher said interest rate differentials are typically a major driver of the currency, and while that relationship had decoupled over the last month or two, "it will be very hard for the kiwi to stay up if the US is raising rates." 

The local currency traded at 91.04 Australian cents from 91.18 cents yesterday and fell to 4.6421 Chinese yuan from 4.6702 yuan. It decreased to 59.01 euro cents from 59.36 cents yesterday and traded at 51.71 British pence from 51.65 pence. It fell to 80.22 yen from 80.48 yen yesterday. 


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