The Australian and New Zealand dollars extended their gains on Wednesday after a softer-than-expected US inflation reading prompted traders to scale back expectations for further Federal Reserve interest rate hikes. The New Zealand dollar briefly touched a one-month high during the session, supported by a combination of reduced Fed tightening bets and growing expectations that the Reserve Bank of New Zealand (RBNZ) will raise rates again in September.
What drove the currency moves?
A cooler US inflation print matters for currency markets because it tends to pull US Treasury yields lower and reduce the appeal of the US dollar. When the return on US cash and bonds looks less attractive, investors often become more willing to hold other currencies, especially those backed by comparatively higher interest rates.
The New Zealand dollar, for instance, jumped as high as $0.6210 against the greenback before settling slightly lower. The Australian dollar also climbed, rising above $0.6800 for the first time in weeks. Both currencies have been under pressure for much of the year as the Fed maintained a hawkish stance, but the latest data has shifted the narrative.
“A softer CPI print is a green light for risk-sensitive currencies,” said one currency strategist. “The Kiwi and Aussie are benefiting from the dual tailwind of a weaker dollar and expectations that their own central banks may need to tighten further.”
RBNZ rate hike expectations add fuel
Adding to the New Zealand dollar’s strength is the market’s growing conviction that the RBNZ will deliver another rate increase at its September meeting. New Zealand’s central bank has been one of the most aggressive in the developed world, lifting its cash rate to 5.5% from a record low of 0.25% during the pandemic. Inflation in New Zealand remains sticky, and recent data on employment and retail spending have suggested the economy is still running hot.
By contrast, the Fed is now seen as more likely to pause or even cut rates later this year, given the cooling inflation picture. That divergence in monetary policy outlooks makes the Kiwi and Aussie more attractive to yield-seeking investors.
The Australian dollar also got a lift from stronger commodity prices, particularly iron ore and coal, which are key exports for the country. However, the Reserve Bank of Australia (RBA) has been more cautious than the RBNZ, holding rates steady at 4.1% in July after a series of hikes. Markets are split on whether the RBA will resume tightening in August.
What it means for everyday investors
For Australian and New Zealand investors, a stronger local currency has mixed implications. On the one hand, it makes imported goods cheaper, which can help ease cost-of-living pressures. On the other hand, it can weigh on the earnings of companies that export goods or earn revenue in US dollars, since those revenues are worth less when converted back to local currency.
Investors with exposure to international equities or US-listed stocks may see a slight drag on returns if the Aussie and Kiwi continue to strengthen. But the broader market reaction has been positive: Asian stocks rallied on the US inflation surprise, with the ASX 200 hitting a near one-month high as banks and miners surged. The Asian Stocks Rally as US Inflation Surprise Eases Rate Hike Fears story captures the broader risk-on mood.
The weaker US dollar also tends to boost commodity prices, which is good news for Australian and New Zealand resource stocks. However, investors should keep an eye on the RBNZ and RBA decisions in the coming weeks, as any surprises could quickly reverse the currency gains.
Broader market context
The US inflation data released on Wednesday showed the consumer price index (CPI) rising at its slowest annual pace in over two years, reinforcing the view that the Fed’s tightening cycle is nearing its end. That sent US Treasury yields lower, with the 10-year note falling below 4.0% for the first time in a week. The Treasury Yields Fall as June Inflation Data Eases Rate Hike Fears article details the bond market reaction.
The dollar index, which measures the greenback against a basket of major currencies, slid to its lowest level in over a month. That weakness has been a boon for emerging market and commodity-linked currencies alike. The Latin American Markets Rally as US Inflation Cools, Dollar Weakens story highlights how the trend is playing out across other regions.
Still, some analysts caution that the rally in the Aussie and Kiwi may be overdone. Oil prices have spiked above $85 a barrel, which could keep inflation pressures alive and force the Fed to maintain a hawkish bias. The Dollar Dips on Cooler CPI, Oil Spike Above $85 Keeps Fed Hawks Alert article notes that energy costs remain a wildcard.
For now, though, the currency markets are enjoying a reprieve from the relentless dollar strength that dominated the first half of the year. Whether that reprieve lasts will depend on whether the inflation data proves to be a one-off or the start of a sustained trend.
