Soc Gen: Go Long on Australian Dollar v New Zealand Dollar

The Australian dollar is forecast to outperform its trans-Tasman cousin say analysts at France’s Societe Generale.

A strategy recommendation from Societe Generale suggests traders buy the Australian dollar using New Zealand dollars ahead of further rises in AUD/NZD.

The call comes at a time of appreciation for the Aussie with strong economic fundamentals and improving commodity markets boosting the complex. The AUD/NZD from around 1.066 at the start of 2016 to the 1.1152 we are seeing today.

A dominant theme for markets has been just how many times the Reserve Bank of New Zealand (RBNZ) intends to cut interest rates in 2016.

The 2.10% basic interest rate in New Zealand is superior to that offered by Australia (2%) ensuring that the NZD remains buoyed by capital inflows seeking higher returns.

A cut to the rate would par the pair; an aggressive cut would turn the yield advantage around. If it were to happen the AUD would presumably advance further.

There are good reasons for the RBNZ to cut rate, historically low dairy prices being paramount, but we note that a hot property market is the one thing standing in between the RBNZ and a haircut of the current 2.10% interest rate.

That said, some analysts see the extension of lending restrictions beyond Aukland as a move that, if implemented, would allow the RBNZ to cut more than once in 2016.

“Likely monetary policy divergence between the RBA and RBNZ should drive AUD/NZD higher,” says Alvin T. Tan, Strategist, at Societe Generale in London.

Tan says New Zealand’s inflation readings are significantly lower than Australia’s, and are under the RBNZ’s 1-3% target range, this gives the RBNZ more space to cut interest rates as one side-effect of lower interest rates is inflation.

The related iron ore price outperformance against the milk powder price adds another bullish near-term factor for the cross.

“The AUD/NZD cross has the added benefit of having a low correlation to global asset markets,” says Tan, ensuring a trade recommendation is not contaminated by external factors.

Strategy Recommendation

Buy AUD/NZD at 1.12, targeting 1.16 initially with a stop at 1.10.

Risks to the Call

The Australian economy is more exposed to the Chinese industrial cycle, warns the Soc Gen analyst, and AUD will likely be hit harder on renewed China growth fears.

“Another risk is that the RBNZ fails to reduce rates by more than the single 25bp cut that is priced in this year,” says Tan.