First, the flow picture is a greater drag on the Aussie than the kiwi. Net
bond inflows to Australia have turned negative sooner and at wider
yield spreads to USTs than we predicted in the May Blueprint. So far
this year net outflows have run at 3% of GDP, and foreign ownership of
sovereign bonds has dropped below 60% for the first time since 2009. Yet
with the post-mining economy dependent on deficit spending, supply will
remain high and Australia relies on foreigners to absorb at least half
of it. Even at the current yield spread it will need a cheaper Aussie to
lure foreign bond investors back. And the pressure is likely to
increase. Long-dated yield spreads closely track front-end rates pricing
and we see risks skewed toward further compression as the market
under-prices a Fed hike in December.
New Zealand by contrast is still seeing net bond inflows.
Moreover, while Australia’s current account has slipped below
cyclically adjusted long-term averages, New Zealand’s improving trade
balance underpins a positive current account trend. The kiwi is now 5%
cheap on our CA-driven FEER models, whereas AUD is 5% rich.
Terms-of-trade trends are likely to exacerbate the divergence. Bulk
commodities are trading rich to our top-down macro models as well as to
our commodity strategists’ bottom-up frameworks. Milk prices by contrast
have bottomed out.
New Zealand’s negative but stable basic balance contrasts favourably
with Australia’s, which is set to extend its deterioration into deficit
in the absence of meaningful depreciation. Moreover, both
current accounts will likely come under pressure as housing booms reduce
saving ratios. In New Zealand, however, this dynamic has less FX impact
because house price inflation is less home-made than in Australia but
driven by offsetting property inflows.