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The New Zealand Dollar was the strongest-performing of the major currencies in the first half of the week, catching a bid in a near-euphoric reaction to news U.S. inflation figures had come in below expectation.
"The Kiwi is holding up well," says David Croy, a strategist at ANZ, adding the way New Zealand's currency bounced after the U.S. inflation report "was remarkable".
The ANZ analyst says this outperformance could come down to "a tighter squeeze" than experienced by other currencies, "given relatively lower liquidity".
The fall in U.S. inflation prompted markets to bet the Federal Reserve had completed its rate hiking cycle, ushering in the prospect of rate cuts in 2024 and an improved global economic outlook. These global factors are supportive of the New Zealand Dollar, however, domestic drivers could be less helpful, mainly as bets for Reserve Bank of New Zealand rate cuts build.
"But from here, it might become vulnerable to lower rates – markets have walked away from expectations for OCR hikes and are now placing 50/50 odds on a cut by May and have 23bp of cuts priced in by July," says Croy. "A similar shift really weighed on the USD, so it’s natural to ask, could that happen here, given we led the cycle?"
Regarding the Pound to New Zealand Dollar, Croy notes the exchange rate has drifted back into the middle of its range, as soft UK CPI data has weighed on the Pound.
"We still worry about what lower NZ rates mean for this cross," says Croy of GBP/NZD.
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The market has also moved to raise bets for UK interest rates in 2024 as economic data has softened since August, and inflation has halved from where it was at the start of the year.
It was reported midweek that UK inflation fell to 4.6% in October, encouraging markets to yet again bring forward bets for UK rate cuts in 2024, resulting in an across-the-board fall in the Pound.
But core inflation (5.7% y/y) and services (6.6% y/y) inflation remain high and could prove reluctant to fall owing to elevated wage rises in the UK.
This could prevent the Bank of England from cutting rates as early as rates markets suggest, which could stem Pound Sterling weakness.
"Expectations that the BoE will cut interest rates by 80bp next year look overcooked. Strong arguments can still be made for UK interest rates to go higher," says Croy.