The Australian and New Zealand Dollars are trading higher on Friday as investors adjust positions to weaker U.S. Treasury yields. The recent rallies in the Aussie and Kiwi are not reflecting stronger economies in Australia or New Zealand, but rather a weakening U.S. economy and a strong possibility of an interest rate cut by the Fed later this year.
Traders aren’t paying too much attention to the economic data in Australia and New Zealand this week, but rather what is taking place in the United States. The domestic data is not likely to have too much of an impact on the Aussie and Kiwi until their respective central banks take a second interest rate cut off the table. In the meantime, traders are more likely to react to the data coming out of the United States.
Also keep in mind that the traders discount future events. For weeks the Aussie and Kiwi fell sharply as investors anticipated the rate cuts by the RBA and RBNZ. Now that the central banks have cut rates, short sellers can cover their positions while allowing the market to rally before the next round of sellers come in ahead of the widely expected second rate cuts.
Furthermore, cutting rates actually brings the economy closer to a recovery. They are designed to stimulate the economy so when a cut takes place, one of the reasons for being short gets dampened.
At this time, bullish Aussie and Kiwi traders are benefitting from the best of both worlds. Firstly, the initial rate cut is over. This is bringing relief to the short sellers who now have a reason to book profits. Secondly, the U.S. economy is weakening and Fed Chairman Jerome Powell hinted at a potential earlier than expected rate cut. This is weakening the U.S. Dollar.
Ultimately, the direction of the AUD/USD and NZD/USD on Thursday will be determined by the direction of U.S. Treasury yields. This is because traders primarily follow the interest rate differential between U.S. Government bond yields and Australian and New Zealand Government bond yields.
If the yields continue to tighten then look for the Aussie and Kiwi to be underpinned. If it widens then the advantage shifts back to the U.S. Dollar.
As long as U.S.-China trade relations remain relatively calm, Aussie and Kiwi traders are going to play the interest rate differential game. If conditions improve then look for the Australian Dollar to pick up some added support. If they weaken, then expected prices to retreat.