NZ Dollar and Aus Dollar Outlook Undermined by Global Money Flows and Decisions at the US Fed

The release of the minutes for the October meeting at the US Federal Reserve has shaken up the exchange rate markets with fresh demand for the dollar undermining the Australian and New Zealand dollars.

While the US Fed's release, details of which are below, was undoubtedly pro-USD, there is the feeling that the dollar's strength could be contained.

"While we think the USD will remain supported, further gains may be difficult unless the sentiment towards the global outlook improves," say Lloyds Bank Research.

A look at the markets at the time of writing shows the two antipodean currencies are holding their ground for the time being:

• The Australian to US dollar exchange rate (AUD/USD) is 0.24 pct lower at 0.8817.
• The New Zealand to US dollar exchange rate (NZD/USD) is 0.23 pct higher at 0.7862.
• The pound to Australian dollar (GBP/AUD) is 0.14 pct higher at 1.8133.
• The pound to NZ dollar (GBP/NZD) is 0.38 pct lower at 2.0324.

Be aware that the above levels are from the inter-bank markets - your bank will affix a spread at their discretion when passing on a retail rate. However, an independent provider will seek to undercut your bank, thereby delivering up to 5% more FX in some instances. Please find out more.

Why are the Aussie and NZ Dollar are Undermined US Fed Tightening?

The outlook for the AUD and NZD ultimately relies on the global money market's response to actions at the US Fed.

Broadly speaking, the AUD and NZD were both key beneficiaries of the 'easy money' years when the Fed was expanding its balance sheet to prop up the US economy.

Cheap dollars were used to invest in higher-yielding assets in places like New Zealand and Australia which both offered superior interest rate regimes.

Now that the US Fed is ending quantitative easing that flood of easy money is drying up.

Furthermore, the prospect of rising interest rates in the US cuts away at the yield advantage enjoyed by NZ and Aus.

Hence, today's news from the FOMC will have added impetus to the flow pressures on the two antipodean currencies.

What did the US Fed Say?

Changes to the FOMC statement leaned in a hawkish direction, a notable divergence from recent market moves that have priced in a later start to the tightening cycle.

The FOMC emphasised that, "Labor market conditions improved somewhat further, with solid job gains and a lower unemployment rate.”

While the first half of that sentence was a holdover from the September statement, the second half was new and indicates growing Fed confidence in the labor market.

In line with that view, the Fed indicated that, "a range of labor market indicators suggests that underutilization of labor resources is gradually diminishing," whereas previously it had said "there remains significant underutilization of labor resources."

The dropping of "significant" is important, because it indicates that the Fed is taking the falling unemployment rate and other signals as valid indicators of improvement.

The Fed also took out the phrase "fiscal policy is restraining economic growth," again indicating greater confidence in the outlook.

"It is notable that the statement did not mention any increase in risks associated with the rising dollar or weaker external growth, a signal that the improving US labor market is a more significant development for the Fed policy outlook," notes Dean Maki at Barclays.

The Fed did nod to lower inflation expectations and falling energy prices in the statement.

Importantly, the FOMC maintained its statement that it is likely to maintain the current near-zero federal funds rate "for a considerable time following the end of its asset purchase program this month."

However, the Fed emphasised two-sided risks to this view by saying, "if incoming information indicates faster progress toward the Committee’s employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated. Conversely, if progress proves slower than expected, then increases in the target range are likely to occur later than currently anticipated."

These phrases are meant to emphasise the data-dependence of the timing of the first rate hike.

The vote for today’s action was 9-1, with Minneapolis Fed President Kocherlakota dissenting because he believe the FOMC should commit to the current target federal funds rate range “at least until the one-to-two-year ahead inflation outlook has returned to 2 percent” and that it should continue its asset purchase program at its current level.

Barclays reckon that, "today’s statement changes do not change our view that the FOMC will be raising rates in June 2015 based on our view of continued labor market tightening reflected in a falling unemployment rate.

"We think today’s statement emphasises that tightening will proceed based on labor market progress, and external factors are only likely to interfere with that process to the extent that they seem to be slowing the labor market."