The New Zealand dollar weakened to a two-and-a-half-month low on Tuesday as growing expectations of additional U.S. interest rate hikes strengthened the U.S. dollar and pressured risk-sensitive currencies.
The kiwi dollar fell 0.2% to $0.5702, marking its fifth consecutive session of declines and bringing it close to the November low of $0.5681.
Meanwhile, the Australian dollar also slipped 0.2% to $0.6990, although it continued to outperform its New Zealand counterpart due to relatively higher yields and stronger investor demand.
Fed Expectations Lift the U.S. Dollar
Currency markets have been heavily influenced by a more hawkish Federal Reserve stance, with investors increasingly pricing in another U.S. rate increase by September.
Higher U.S. interest rates generally strengthen the dollar because they increase returns on dollar-denominated assets, making currencies such as the Australian and New Zealand dollars less attractive.
Australian Dollar Gains Advantage Over Kiwi
The Australian dollar has benefited from its yield advantage, with investors favoring it as a carry trade currency. The AUD/NZD exchange rate recently traded near NZ$1.2251, close to a 13-year high.
Ray Attrill, head of FX strategy at National Australia Bank, noted that periods of low currency market volatility tend to favor higher-yielding currencies.
In this environment, the Australian dollar has become increasingly attractive relative to the New Zealand dollar.
RBNZ and RBA Policy Outlook
Markets expect the Reserve Bank of New ZealandReserve Bank of New Zealand to raise its official cash rate by 25 basis points in July, taking the policy rate above the current 2.25%.
Investors currently expect New Zealand interest rates to reach approximately 3.35% by the end of next year.
Meanwhile, the Reserve Bank of AustraliaReserve Bank of Australia is widely expected to keep rates unchanged at 4.35% in August, although markets still see some possibility of another increase later this year.
Bond Markets Reflect Changing Rate Expectations
Australian government bonds have outperformed U.S. Treasuries, with three-year Australian yields falling to around 4.43%. The yield advantage over comparable U.S. bonds has narrowed significantly since March.
New Zealand bonds have also strengthened, with 10-year yields declining to approximately 4.47%, causing their yield spread against U.S. Treasuries to turn slightly negative.
Market Outlook
The kiwi remains vulnerable as investors favor the stronger U.S. dollar and seek higher-yielding opportunities elsewhere. While both Australia and New Zealand maintain relatively elevated interest rates, Australia's yield advantage and stronger carry appeal continue to support the Australian dollar.
Upcoming U.S. inflation data and central bank meetings will likely determine whether the U.S. dollar extends its gains and whether further pressure emerges on the New Zealand dollar in the coming weeks.
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