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Forex Flash: Stay short AUD/NZD on monetary convergence – UBS

We entered a short AUD/NZD trade recommendation on January 31st largely on the view that monetary policy settings in Australia and New Zealand are likely to converge. According to Research Analyst Gareth Berry at UBS, “There is another reason to stay bearish on the cross too, given bond market dynamics are soon likely to tilt in the New Zealand dollar's favor.”

The smaller size of New Zealand's asset markets means NZD has a limited capacity to absorb portfolio inflows from overseas, however the balance is likely to shift somewhat over the coming years in response to a diverging pace of bond issuance. New Zealand's sovereign bond market is due to expand while the size of Australia's stabilizes.

However, we don't have to wait years for the currency to feel the impact. Foreigners are under-represented in the NZ bond which matures on April 15th, 2013, though we believe forthcoming issuance should present a good opportunity to significantly increase their holdings more generally. “As the April bond matures and as auctions continue throughout this year, we are likely to see an increase in the share of NZ bonds held by foreigners. Although both currencies have benefited from bond inflows in the past, NZD seems likely to benefit more from this over the coming year and as such we recommend staying short AUD/NZD.” Berry notes.

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