How Quickly We Forget


REMEMBER THAT AUSTRALIAN DOLLAR? - It wasn't too long ago that the high flying Australian Dollar was everyone's favorite currency with expectation that the rate would easily clear 1.1000 on its way to the moon. But this was not to be, with the currency well overvalued and on the verge of falling victim to a combination of mean reversion, a slowing economy and overly optimistic central bank. Enter present day and we have a strikingly similar story going on with the New Zealand Dollar. The currency tracks at longer-term cyclical highs, has an overly optimistic central bank, and yes, is showing signs of cooling off. I remember with the Australian Dollar, market sentiment flipped in an instant, and just as you couldn't remember why there was any reason to be selling the currency, all of a sudden, no one could justify ever wanting to own Australian Dollars. This is how fickle markets can be and just how quickly the picture can change. I think the first signs of the shift came when economic data out of Australia was still looking ok, but was starting to come in below expectation. This subtle transition was the catalyst that sparked the explosive reversal. So now back to the New Zealand Dollar. The RBNZ has been quite vocal with its discomfort of the NZD exchange rate and does not expect these levels to be sustainable. At the same time, the central bank has taken on a less aggressive stance, while economic data over the past couple of weeks is starting to come in on the softer side of expectation.

I remember with the Australian Dollar, market sentiment flipped in an instant, and just as you couldn't remember why there was any reason to be selling the currency, all of a sudden, no one could justify ever wanting to own Australian Dollars. @jkonfx

JUST LIKE THAT - What have we seen over the past couple of weeks? Well, inflation was softer, employment disappointed, retail sales were weaker, and today's manufacturing PMIs were below consensus. Now throw into the equation some potential weakness on the horizon in global equities, more downside pressure in risk correlated USD/JPY and EUR/CHF, signs of uncertainty within the Chinese economy, and ongoing geopolitical risk, and the outlook for the New Zealand Dollar should be a lot less rosy than what the market has been making it out to be. So why is the currency still bid? Well, market participants don't want to think about all of the important stuff. All that matters in this environment is yield, and that's all anyone can think about. Think of yield as a piece of bread in a world starved for food. To investors, yield is like nourishment, and without yield, investors can not survive. But as I have warned repeatedly, it is a very dangerous thing when investors care less about the asset and more about the incentive to buy the asset. This creates shaky foundations and is a recipe for disaster. At the moment, there has been no evidence of such capitulation in the New Zealand Dollar, but the signs are there and I would say to make sure not to blink, or you might just miss it. Technically, a break back below 0.8600 would do a good job of encouraging the anticipated reversal, exposing the more critical support floor at 0.8515. Right now, 0.8515 might seem like it is miles away, but don't be fooled, those miles can easily turn into steps in a heartbeat.


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