New Zealand Dollar: Extreme shorts face a high bar for further losses – MUFG

MUFG’s Derek Halpenny sees a tension between aggressive Reserve Bank of New Zealand (RBNZ) tightening expectations and increasingly stretched short positioning in the New Zealand Dollar (NZD). While softer labour-market conditions cast doubt on nearly 100bps of tightening priced over the next year, the bank argues that bearish NZD positioning may already be extreme. A more attractive Australian yield profile continues to favour AUD/NZD, although potential El Niño-related terms-of-trade support could limit further NZD downside.

RBNZ doubts versus stretched NZD shorts

"The weekly IMM positioning data is a data series tracked by many without necessarily throwing out a strong message but the positioning for the New Zealand dollar is definitely worth highlighting. The latest data, to the week ending 11th August, revealed Leveraged Funds’ total short position had hit a record in the series of the data going back to 2006."

"On a year-to-date basis NZD is actually the third best performing G10 currency after NOK and AUD. The RBNZ policy rate currently stand at 2.50% but the OIS curve implies expectations of nearly 100bps of tightening over the next 12mths."

"The positioning could also reflect scepticism over the ability of the RBNZ to deliver 100bps of tightening over the next year. The labour market showed the unemployment rate increased from 5.4% to 5.6% despite a strong increase in employment highlighting increased labour supply and greater economic slack than assumed."

"We would certainly concur with the view that the OIS curve for the RBA may be underpriced (less than one hike priced over 12mths) and the RBNZ pricing is too aggressive. The positive AUD angle also incorporates energy and Middle East risks are more a benefit for AUD than NZD."

"While 100bps of tightening may prove excessive, the scale of short NZD positioning looks more extreme and we would argue at this level, the bar is relatively high for a notable leg lower for NZD. We should also be mindful of a potential flip in the terms of trade bias. The El Nino risks point to clear upside potential for food inflation over the coming 6mths and that could provide NZD with a positive terms of trade lift."

"Finally, the positioning may well reflect a bilateral view versus AUD. The AUD/NZD cross is key for NZD and there remains a far more attractive yield pick-up in Australia with the RBA continuing to communicate a relatively hawkish message on the potential for another rate hike."