NZD/USD milking it as surging dairy prices, US dollar weakness deliver bullish breakout

• NZD/USD has been among the top performing G10 FX pairs in August
• US dollar weakness is being driven by mounting Fed rate cut expectations
• And that’s contributed to a surge in dairy prices which is benefiting the Kiwi
• NZD/USD has broken key resistance after a powerful rally from .5985
• Markets price in more than 100 basis points of cuts from the RBNZ by February

Overview

Plenty of FX names have enjoyed a rare moment in the sun against the almighty US dollar recently, but few as much as the Kiwi. NZD/USD has been milking the dollar’s droopiness, surging to multi-month highs on the back of soaring dairy prices. The latest leg higher has propelled the Kiwi through important technical resistance, pointing to the increased risk that this rally may have legs.

You can cut before the Fed without destroying your currency... 

Remember the doomsayers warning the Kiwi would be swirling down the gurgler if the Reserve Bank of New Zealand dare cut rates before the Federal Reserve? Yeah, how’s that call working out? Even with markets pricing in more than 100 basis points of cuts from the RBNZ by February, including the risk of a 50 in October, the Kiwi is flying in August. While domestic factors are always a consideration, for a small, open economy like New Zealand, it’s offshore factors that matter far more for the Kiwi.

You can see that in the chart below.

The top pane shows daily movements in whole milk powder futures listed on the NZX, providing a guide on how dairy export values and New Zealand terms of trade may fare in the months ahead. There’s been a more than 10% rally in the second-month contract, leaving it staring at the potential of multi-year highs.

Softer US dollar benefitting milk price, Kiwi

So, has the world rediscovered their taste for dairy produce, explaining the sudden surge in prices? Maybe, but one look at the second pane shows the weakening in the US dollar is acting like a release valve for previously depressed dairy prices, sitting with a rolling daily correlation -0.85 over the past month. Where the dollar has moved, dairy futures have typically moved in the opposite direction.

The third pane shows the Kiwi is literally milking the rally in dairy, with the daily correlation over the past month strengthening to 0.87.

DXY looks terrible as Fed rate cut bets swell

This next chart goes someway to explaining why the big dollar is suddenly swaying like a prize fighter who’s taken a hit to the jaw, with the US dollar index breaking down on the weekly, slicing through an important support zone like a hot knife through butter.

The other influence has been the sharp drop in US two-year bond yields with the weekly correlation over the past three months standing at 0.89, suggesting it's negatively impacting the dollar by reducing its yield appeal. Unless we see concerns about a hard landing for the global economy escalate, or a sudden turnaround for the US economy, the dollar looks like it may be on the backfoot for a while.

And that may be good news for Kiwi bulls considering where NZD/USD sits on the charts.

NZD/USD stages bullish breakout

As a result of the latest bounce from strong support at .5985, NZD/USD has broken above some key technical levels, taking out horizontal resistance at .6150 and downtrend that dates back to the highs struck in 2021. Should the price get established above this former resistance zone, it may act as a launchpad for further gains on the period ahead.

Those considering longs could buy above .6150 with a stop loss order below for protection. .6218 comes across as an obvious target with .6277 and .6370 the next major topside levels after that.

The biggest near-term risk would be Fed Chair Jerome Powell conveys a far less dovish outlook for rates than markets currently price (eight cuts are favoured by June) when he speaks at the Jackson Hole economic symposium on Friday. While outright hawkishness is unlikely, any disappointment could spark a reversal NZD/USD given stretched near-term positioning. If we were to see a reversal, NZD/USD may sink lower towards support at .6049.

-- Written by David Scutt

Follow David on Twitter @scutty