HiFX's Dan Bell sees a break-down in risk-on, risk-off trade for the NZ dollar where it follows Wall Street up and down as US dollar follows US shares up

Here's our weekly currencies outlook and review with HiFX's Senior Dealer Dan Bell, who says with brighter news emerging from the United States economy, the currency market has calmed down.

The latest sign of life in the US economy came overnight with news US retail sales grew a stronger-than-forecast 1.1% in September.

"Last week we had some better housing numbers, we've also had a better consumer sentiment report and the employment numbers at the start of the month were also better than expected for September," says Bell. "So you've got a slightly better housing market, better retail sales, better employment figures in the US. So there's some encouraging signs there that maybe this whole QE (quantitative easing) stimulus regime from the Fed is working."

"It has been a long time and the US continues to struggle. But at this stage their fundamentals are certainly looking a lot better than a lot of other developed economies, ie Europe, which is in a recession or depression, the UK and even New Zealand and Australia, (where) whilst we are doing okay, we're certainly not generating amazing growth at the moment."

In the US the Federal Reserve has held official interest rates at 0% to 0.25% since December 2008 and effectively printed trillions of US dollars through three rounds of QE as it has desperately tried to kick some life in the country's economy after the subprime mortgage market crash and onset of the global financial crisis.

Now, with major US listed firms reporting third quarter earnings, there are some signs of, and claims of, life in the US housing market. JP Morgan Chase & Co posted record quarterly profit helped by a 36% increase in mortgage lending revenue and, according to the US Mortgage Bankers Association, applications for home loans rose 17% in the week ended September 28 from the previous week. JP Morgan CEO Jamie Dimon said: "We believe the housing market has turned the corner.”

'Break-down in the correlation of the risk-on, risk-off trade with US equity strength supporting US dollar'

Bell says the currency market's feeling a bit calmer at the moment than it has for some time.

"I think what we are seeing is a little bit of a break down in the correlation of the risk-on, risk-off trade where the New Zealand dollar was always going to go up when we saw a positive move on Wall Street," says Bell.

"That correlation has broken down a little bit so the better than expected news we're seeing in the US, which is giving US equities a little bit more upside, is actually supporting the US dollar and in the last few days gold prices have come down a bit."

Meanwhile, New Zealand's Consumer Price Index (CPI) shows inflation rose just 0.8% in the year to September and just 0.3% in the September quarter from June, leaving inflation at its lowest point since 1999, and dropping below the Reserve Bank’s 1%-3% target band in the September year. Eyes are now turning to the Reserve Bank. With new Governor Graeme Wheeler at the helm, the Reserve Bank is due to review the Official Cash Rate (OCR) next Thursday, October 25.

"I don't think most economists or analysts think that we're going to see the Reserve Bank cut next week," Bell says. "I think the OCR will stay at 2.5%. But the market is starting to price in the potential for a rate cut and so the lower inflation number is adding to that."

"And looking across the ditch Australia is expected to cut interest rates again on November 6. They cut interest rates recently (by 25 basis points to 3.25%) so with Australia cutting rates and New Zealand on hold, it puts us in a little bit of a tricky position because the New Zealand dollar-Aussie cross rate has been quite strong recently," adds Bell.

 The New Zealand dollar traded as high as A80.80 cents last week, and although a bit weaker this week, Bell says it's still trending up.

"Certainly if we see the Reserve Bank of Australia cut rates once again the Kiwi-Aussie cross rate will continue to go up. Our target is A82.50c. The 10-year average is closer to A84c, and as we know, Australia still is our largest trading partner and if we see further strength in the Kiwi-Aussie cross rate it's going to make our exports into Australia less competitive where their economy is already slowing."

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Dan Bell is the Senior Dealer at HiFX, a UK-headquartered foreign exchange dealer with significant operations in Australia and New Zealand. It has a dealing room in Auckland. See more detail here.