Australian and New Zealand dollars suffer as bond markets show resilience

Key Takeaways

Australian and New Zealand dollars lose value amid rising US yields.
Reserve Bank of Australia expected to hike rates by 25 basis points in September.
Bond markets outperform US debt but still face significant losses.

The Australian and New Zealand dollars have experienced substantial losses this week, with the Aussie dollar falling to a seven-week low at $0.7010. The New Zealand dollar also declined, closing at $0.5659, marking a fifth consecutive week of losses.

The decline in both currencies is attributed to the surge in US yields, which have buoyed the greenback. Despite the narrowing odds of further rate hikes, the Reserve Bank of Australia (RBA) is expected to raise interest rates by 25 basis points to 4.60% at its meeting on September 29. Markets anticipate a 25 basis point hike in November as well.

Paul Bloxham, head of Australian economics at HSBC, expressed confidence in the RBA's resolve to combat inflation, noting that core inflation has been above the 2% to 3% target band for over four years. Data expected next week are projected to show core inflation at 3.6% or slightly higher in August.

However, the RBA's hawkish stance is not the only factor affecting the Australian dollar. Markets are even more aggressive in their expectations for the Federal Reserve, with a 68% chance of a rate hike in October and around 90 basis points of tightening by the middle of next year. This has left the Aussie dollar hanging at $0.7010, down 0.4% overnight and 1.6% for the week.

In contrast, domestic bonds have shown some resilience, outperforming US debt despite significant losses. Ten-year yields have climbed to 5.408%, but the spread over Treasuries has almost halved in recent weeks to 22 basis points. This performance has helped to mitigate some of the losses in the bond market.

The New Zealand dollar, meanwhile, has also suffered, closing at $0.5659 after a 0.2% decline overnight. This marks a 1.2% loss for the week, with the currency now approaching its 2026 low of $0.5627. Major support is seen at $0.5581.

The retreat in both currencies poses a significant challenge for central banks, as it threatens to increase import prices and add to inflationary pressures. Markets now imply an 84% chance that the Reserve Bank of New Zealand (RBNZ) will hike rates by a quarter point to 3.0% at its next meeting on October 28, with further hikes expected to push rates toward 4.0%.

Economists predict that a combination of higher interest rates and rising import costs could lead to economic growth stalling in the fourth quarter and first quarter of next year, with a risk of recession. The ongoing volatility in the currency markets highlights the complex interplay between global economic conditions and local monetary policies.