The NZDUSD has made a series of lower highs and lower lows in what may the beginning of a larger downtrend. 7446 needs to hold in order for any bearish counts to remain on track. A break of 6800 would shift focus to 6600. Rallying above channel resistance (at 7252 this month) would indicate that the NZDUSD is probably headed above 7446 and then 7640. Overnight Index Swaps predict that New Zealand Dollar interest rates will remain comfortably above US Dollar equivalents through the coming year, but a recent improvement in Greenback rate expectations has limited yield-linked NZDUSD rallies. The spread in 12-month rate expectations shows that the NZD-USD yield spread will likely grow by another 75 basis points through that time period. Yet the above chart shows that this is noticeably below recent peaks and the short-term trend points to a pullback in NZDUSD expectations. Much like our forecast for the Australian Dollar/US Dollar currency pair, the shift in expectations may be just enough to push the NZDUSD lower through upcoming trade. The New Zealand Dollar is only second to its Australian counterpart in terms of overvaluation against the greenback, trading 17.8% above its “fair” exchange rate. Ironically, the currency’s gains may see their own undoing considering RBNZ governor Alan Bollard has mentioned on more than one occasion that the central bank would have likely started to raise rates sooner had the exchange rate not acted as a buffer against inflation. This means that NZD lacks the immediacy of robust policy expectations enjoyed by the other two commodity dollars. Support from risk appetite is also fleeting, with NZDUSD’s correlation to the MSCI World Stock Index (0.6) substantially lower than that of the Aussie (0.7) and the Loonie (0.78). Finally, the bearish scenario is bolstered by a recently released IMF report that claimed the NZ unit was overvalued by 10-25 percent and forecast that this state of affairs was temporary, hinting that a downswing was to be expected. With a 1219 pip gap between spot and PPP, a short position looks compelling and we will look for selling opportunities. One of the oldest and most basic fundamental approaches to determining the “fair” exchange rate of one currency to another relies on the concept of Purchasing Power Parity. This approach says that an identical product should cost the same from one country to another, with the only difference in the price tag accounted for by the exchange rate. For example, if a pencil costs €1 in Europe and $1.20 in the US, the “fair” EURUSD exchange rate should be 1.20. For our purposes, we will use the PPP values provided annually by Bloomberg. We compare these values to current market rates to determine how much each currency is under- or over-valued against the US Dollar.

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