Woeful dairy auction has NZD/USD down below 66c; Fed targeting rate hike by year end; commodity currencies hit hard

By Raiko Shareef

Commodity currencies are under the pump this morning, with NZD the biggest loser after a woeful dairy auction result.

The USD is broadly stronger, thanks to a trio of positive economic reports, and Fed speakers affirming that a 2015 rate hike remains in their sights.

Rosy-looking Chinese data yesterday failed to spark a sustainable rally in AUD and NZD.

NZD/USD is 1.8% lower, and making fresh 5-year lows just below 0.66. The sharp fall in the GlobalDairyTrade Index was at the worse end of our expectations, and the Index now sits at its weakest since 2003.

The signs leading up to the auction were not promising, especially the broader weakness in commodity and financial markets, stemming in large part from China.

Earlier this week, we revised lower our 2015/16 milk payout forecast from $5.20kg/MS to $4.70kg/MS. The risks around this revised forecast are likely now negative.

We’re a little surprised to see such a sharp move, as we’d imagined investors were somewhat inured to negative NZ news.

But NZD/USD’s weakness this morning has been exacerbated by a better bid USD across the board, and broader pessimism toward commodity currencies.

The CAD is 1.6% weaker this morning after the Bank of Canada cut its policy rate by 25bps to 0.50%.

Governor Poloz cited a downgraded outlook for growth, which increased the downside risks to inflation.

The collapse in the oil prices, Canada’s key commodity export, has had a more protracted effect than previously anticipated.

With that in mind, we can’t blame international investors from drawing parallels between Canada, New Zealand, and indeed Australia.

The AUD completes the triplet of major commodity currencies, and was dragged along for the ride, sitting 1.0% weaker this morning.

The BoC’s admission that the ‘output gap’ is significantly larger than anticipated will strike close to home here in NZ.

The ‘output gap’ is central bank parlance for the amount of slack in the economy, an aspect the RBNZ has had to serially revise upward over the past 18 months.

Where to from here, for NZD/USD? There is a strong line of support at 0.6560, which marks the 2010 low.

The trend channel support appears below that, at 0.6500. Momentum suggests these levels will be tested in the very near future, especially if today’s CPI report undershoots market expectations.

Even with a modest upside surprise, we expect rallies toward 0.6650 to be sold. We’d been expecting the extremely large existing short positioning in NZD to slow the descent, but there is little evidence of that being the case.

After today’s local CPI report, we’ll be looking to Europe’s CPI report and ECB President Draghi’s press conference this evening.

Note that, as this note goes to print, Greece’s parliament is debating the bailout proposal. While the measures will likely be passed, there remains significant implementation risk. We’ll be watching EUR carefully.

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Raiko Shareef is on the BNZ Research team. All its research is available here.