Central Bank Divergence
One of the difficulties in FX recently has been the fact that central banks have been cutting rates in a co-ordinated way. This has made a central bank divergence trade tricky. However, the latest moves by the RBNZ have helped create a divergence between the AUD and the NZD by their willingness to move to negative interest rates.
The NZD was hit hard on Wednesday. The RBNZ Monetary Policy Committee agreed to significantly expand the Large Scale Asset Purchase (LSAP) programme potential to $60 billion. However, this was expected, it was the possibility of negative interest rates which caused the most damage to the kiwi. The deputy Governor Geoff Bascand clarified that the RBNZ would like to be ready for negative rates by the end of the year.
Given the fact that New Zealand have already broken out of COIVD19 induced lockdown measures I was surprised by the dovish tilt. So, we have to remember that there is possibility of a domestic improvement which negates the need for negative rates. However, for now, negative rates remain in view for the RBNZ. This is what has created the NZD weakness.
RBA vs RBNZ
The Reserve Bank of Australia, by contrast, is less inclined to negative rates and does not favour them. So, we can therefore expect to see a divergence between the AUD and the NZD. Due to this situation the yield spread between the Australian and New Zealand 10 year bond will be set to widen. See the chart here from a Bloomberg piece on this yesterday showing the yield spread difference between the tow 10 year bonds (white line):
Therefore, look for pullbacks on the AUDNZD pair and expect buyers to enter as long as this central bank divergence remains.
