Front-end rate differentials indicate AUD should be weaker however, the AUD rally we have seen over the last few months reflects the rise seen in bulk commodities. We need to assess the strength of the rise of bulk commodity prices as we see a pullback being the stimulus to AUD trading lower again.
China is transitioning their economy away from the commodity dependent sectors (old China) to a consumption-based economy dependent on the service sector (new China). This transition will challenge the uptrend we are seeing in iron ore prices which has seen spot prices rise over 60% in the last 12 months. Iron ore supply is highly elastic which can create over-supply issues. We currently view iron ore prices as being inflated and expect to see a pullback in iron ore prices based on valuation metrics and not via falling risk sentiment, which we view as being stable.
The next leg lower in AUD will be driven by yield differentials, soft economic fundamentals keeping the RBA on the sidelines and a pullback in iron ore. The risk to this view is if iron ore prices remain propped up by Chinese stock piling or a boost in risk appetite via positive developments from US politics.
The NZ output gap is close to being closed and inflation is on track to overshoot the Reserve Bank of New Zealand (RBNZ) target. RBNZ have noted global uncertainties so we expect to see them leave rates unchanged. Markets are currently pricing in tightening within the next 12 months, which we believe will be priced out leading to a soft NZD.
NZD reacts adversely to market volatility. With a vast amount of risk events and uncertainties remaining, we see NZD facing significant headwinds. We see AUD more exposed than NZD to a China slow down. We are bearish AUDNZD but wait for a better level to enter short positions.
The Bank of Canada (BoC) have signalled room for more cuts but data over the last 3 months, particularly labour market, has been solid. This positive economic backdrop may lead markets to price in BoC hikes which would give CAD a boost. While oil prices have sold off sharply the CAD has become less sensitive to oil price fluctuations as Keystone Pipeline developments have acted as cushion for the currency. We view current levels in AUDCAD as a good short opportunity as we are more constructive on oil vs iron ore and Canada’s fundamentals.