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Dollar-bloc currencies rebut the foreign exchange script

Dollar-bloc currencies are not sticking to the general script that foreign exchange markets are in the midst of a lull, neutralised by low volatility, the easing of political risk and a favourable global growth climate

The currencies of Australia, New Zealand and Canada are being knocked around like a pinball as they have fallen since the second quarter began. The Australian, or Aussie, dollar has dropped 3.5 per cent against its US counterpart, the Canadian dollar, or “loonie”, by 2.8 per cent and the New Zealand dollar, known as the “kiwi”, by 2.3 per cent.

The declines do not reflect a wider strengthening in the US dollar. While the yen is also 2.4 per cent lower since the beginning of April, several currencies have strengthened against the US dollar — by at least 2 per cent in the case of the British pound, the euro, the Polish zloty, the Czech krona and the Danish krona.

Local reasons are driving some of the dollar bloc declines. The kiwi fell 1.5 per cent on Thursday to its lowest level in nearly a year after a surprise no-change rates decision by the Reserve Bank of New Zealand, which investors thought was leaning towards tighter policy on the back of a strong economy and rising inflation.

The loonie dropped 0.4 per cent after rating agency Moody’s downgraded Canadian banks, citing high levels of household debt on Wednesday. It also has Trump-driven trade problems to contain.

Analysts also note how dollar bloc currencies are feeding off each other’s bouts of weakness.

Stephen Gallo of Bank of Montreal said the RBNZ decision was “the catalyst that led the bloc lower against the dollar in general” on Thursday.

Similarly, according to Adam Cole at RBC Capital Markets, the Moody’s banks downgrade has spillover effects. “Markets rightly assume that the banking sectors in all three are similarly structured, so what’s bad for Canadian banks must be bad for all three,” he said.

Broader macro issues also explain the falls in these three currencies — commodity prices, and growing rate differentials. Commodity prices are under pressure.

Steven Saywell at BNP Paribas said, “it’s all about China”, where liquidity is being tightened.

“That’s what is really driving price action in the past month or so,” he added.

Some of these commodity-related moves look a little out of kilter. Analysts note the kiwi was already being marked down before the RBNZ decision, which was odd considering prices in its biggest export market, dairy, were holding up rather well. The Aussie looks vulnerable to further falls if prices in iron ore keep sliding.

Tracking commodity prices to currencies is not as straightforward as investors expect.

They might have expected the loonie to rally on Wednesday’s rise in crude oil, but as John Hardy at Saxo Bank noted, the banks downgrade “easily outpaced” the implications of firmer oil prices.

A key issue for the dollar bloc is that of interest rate differentials. Investor attention is being pulled towards next month’s Federal Reserve meeting, when overnight rates are expected to rise, with another shift higher possible in September. Yet far from following the Fed down the rate tightening path, other central banks seem to be pulling in different directions.

As Kit Juckes of Société Générale says about the RBNZ decision, “it says something about the shift in the market mood . . . that a ‘dovish hold’ is a big event”.

The focus of investors on every potential signal of rate normalisation around the G10 universe explains recent rallies in the euro and the pound. When central banks disappoint the market, it is tempting to conclude that they are motivated partly by the desire to keep their currencies lower.

It is possible, says Rabobank’s Jane Foley, that the RBNZ “saw an opportunity to take advantage of the market’s more hawkish view to verbally manipulate the kiwi lower”.