Long AUD/NZD: The Next Divergence Trade‏

We recommend to buy AUD/NZD spot at 1.2733 with a 1.3000 target and 1.2600 stop to position for continued divergence between Australia and New Zealand - this provides an approximate carry of 0.7% p.a. Although we remain bearish on the cyclical currencies as a whole for the near term due to US fiscal woes, we think there is scope for more aggressive pricing of the Reserve Bank of New Zealand (RBNZ) relative to the Reserve Bank of Australia (RBA) as Australia benefits from past rate cuts and a stabilisation in China. Long AUD/NZD could be viewed as the new divergence trade: partly playing a continued Aussie-Kiwi data gap and partly continued fiscal cliff concerns, favouring triple-A rated currencies.

Earlier this week we took profit in our 1M AUD/NZD risk reversal, see FX Position Update, 12 November, but we still like the pair and suggest positioning for further divergence between Australia and New Zealand. The discrepancy we are starting to see manifesting itself down under resembles that seen in the Scandi region in recent months, which has led to a sustained upward move in NOK/SEK that may not have much further to go.

Indeed, AUD/NZD could become the new divergence trade, which is at the same time partly insulated from US fiscal cliff concerns. Thus, long AUD/NZD could be viewed as the new divergence trade, partly playing a sustained Aussie-Kiwi data gap and partly demand for triple-A assets amid fiscal cliff concerns.

The data flow has moved in favour of AUD recently, as Australian data has become less bleak with decent employment growth and retail sales and, notably, Q3 inflation surprising on the upside. The data flow out of New Zealand has also been reasonable but a marked rise in the unemployment rate and dismal retail sales were seen in Q3. We expect to see Kiwi data deteriorate further as the boost from earthquake reconstruction gradually starts to wane and the burden of the strong NZD is felt. In contrast, Australia is set to benefit from the stabilisation in China that we see materialising in Q4; indeed, this has already been fuelling iron-ore prices.

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