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  • NZD/USD has been on the front foot in recent trade and advanced to fresh multi-year highs amid broad USD weakness. 
  • A relation trade that is lifting commodity markets is benefitting commodity-linked currencies such as NZD.  

NZD/USD set fresh multi-year highs in recent trade above the 2020 high set on 31 December of 0.72409. At present, the pair trades in the 0.7250s with gains of around 1.1% or 80 pips. USD has been weakening across the board in recent trade and most USD major pairs have been on the front foot; the Dollar Index (DXY) has slipped into the 89.50s and is eyeing a fall back towards Monday’s lows in the 89.40s.

NZD might be deriving some support from recently released and very strong GlobalDairyTrade (GDT) auctions results; the GDT price index rose 3.9%, with prices up to $3420 per tonne versus $3317 last week. Moreover, the Whole Milk Powder price rose 3.1% to $3306 per tonne from $3210 previously. Dairy is one of New Zealand’s top exports.

Reflation trade

More broadly, whilst global markets are tentative ahead of key events later in the week (including the Georgia Senate election, Congressional certification of the Presidential election result, ISM services PMI and NFP numbers for December), a reflation trade is underway; commodities are gaining across the board (WTI +4.3%, spot gold +0.4%, spot silver +0.9%, copper +2.2%) and bond markets also point to growing inflation bets.

The spread between the US 5-year bond yield and US 30-year yield reached its highest since 2016 or 134.6bps and US 10-year break evens are now set comfortably above 2.0% at 2-year highs. A huge jump in the prices paid subcomponent in Tuesday’s ISM manufacturing PMI numbers for December, although driven predominantly by supply chain issues, seems to have added to the “return of inflation” narrative.

This reflation trade appears to be weighing on the US dollar; in the past, rising inflation expectations might have triggered USD strength as it would have gone hand in hand with higher expectations for monetary policy tightening from the Fed.

However, this time is different; the Fed indicated last year that for the first time ever, it will be comfortable with letting inflation run hot for a period of time to make up for prolonged periods of time. In other words, if inflation does run hotter than expected, the Fed is likely to be behind the curve in bringing back under control. This is, of course, a negative for USD as there is greater scope for an erosion in the purchasing power of the US dollar.

As inflation expectations rise, the currencies of commodity export dependant economies such as New Zealand and Australia stand to be amongst the greatest beneficiaries of this trend.