In the battle of the antipodean currencies, Westpac is backing the Aussie dollar

One day, Michael. Photo by Brett Hemmings/Getty Images

While small in terms of population and economic importance, at least from a global perspective, there are few currencies around the world than traders like to dabble in more than the Australian and New Zealand dollars.

The high-yielding, commodity-linked antipodean pairing punch above their weight in terms of market share, meaning there’s always plenty of interest in which direction they’ll head next.

And that includes the AUD/NZD itself.

After yet another failure to break below parity for the first time ever in early February, the Aussie has performed strongly in the two months since, at one point rallying close to 7% against its Kiwi compatriot before giving back some ground in recent weeks.

The daily chart below shows the recent price action.

AUD/NZD Daily Chart

After such a strong run, it’s left many wondering what will happen next.

Sean Callow, senior currency strategist at Westpac, has been looking into the antipodean pairing in a research note released earlier today.

He believes the Aussie remains a “buy-on-dips” prospect, with the Aussie still undervalued against the Kiwi based on modelling undertaken by Westpac.

“We have long argued that the pair was undervalued so view the move as largely catch-up to fundamentals. Some consolidation in recent days doesn’t change our underlying inclination to buy dips in the cross,” he says, noting that even with the recent rally, the Aussie still remains some 4 cents below what he believes to be fair value.

“Our preferred buy zone is near 1.0750, targeting 1.10 plus.”

Whether the AUD/NZD dips as far as Westpac’s 1.0750 “buy zone” in coming weeks will probably depend upon increasingly volatile iron ore prices and broad risk appetite, says Callow.

This chart from Westpac shows where the AUD/NZD currently sits compared to Westpac’s fair value model, which is determined by factors such as interest rate differentials and relative commodity prices of the two nations.

Source: Westpac

While Callow sees the pair moving higher — hence why he suggests investors should buy the dip — he doesn’t believe that the gap between the current spot rate and Westpac’s fair value estimate to fully close any time soon.

“Fair value estimates are always a simplification of a currency pair’s fundamental drivers, so deviations from the spot rate can persist for some time,” he says.

“The current phase of AUD/NZD undervaluation has been both unusually large and sustained, though the narrowing of the gap in recent weeks increases our confidence in the model estimate.”

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