Nick McDonald: Transtasman dollar battle - A Kiwi victory?

There has been talk in trading circles recently of AUD/NZD reaching, or even declining below, the magic parity level of 1.0000. Dipping below that level would mean that one Australian dollar is worth less than one New Zealand dollar.

To many Australians that would be as bad as losing a cricket test to the Black Caps (which surely will happen again soon enough) or having another yet another decade of Bledisloe Cup deprivation.

It is a friendly rivalry that I refer to here between two countries that happen in this case to be very close to each other. Believe it or not this exact rivalry can provide great trading opportunities when two currencies reach parity - not just the Aussie versus the Kiwi.

AUD/NZD trades at 1.0850 as I type this (Friday 21st Feb) and has been as low as 1.0490 in recent months. It has already fallen significantly from highs above 1.3000 in 2012. It's a classic rival of the bulls versus the bears while at the same time, pitching country vs country. Who will win the currency battle?

Camp 1 - The Fundamental Case for Parity

Economists and forecasters are predicting RBNZ rate hikes in the coming months and some predicting as much as a 2 per cent rise or 200 basis points in the next two years. The New Zealand economy is expected to grow this year at its fastest rate since pre-GFC days and there is a consensus that New Zealand will grow faster than Australia in 2014.
This combines to put more upward pressure on NZD and downward pressure on AUD, pushing AUD/NZD towards parity.

Camp 2 - The Fundamental Case Against Parity

Those who believe AUD/NZD will not get there, largely argue that RBNZ rate rises have been expected for quite some time and are already priced into the current exchange rate. In other words, if we get a New Zealand interest rate rise in March, it will be no surprise to the market and is unlikely to have much downward effect on AUD/NZD. Likewise subsequent RBNZ rate rises thereafter.

They also suggest that any small uptick in the Australian economic outlook from here, which some are anticipating, will make parity a pipe dream.

Camp 3 - The 'trade what you see, not what you think' Camp

I personally don't sit in either camps 1 or 2 although I do keep an eye on them both and would be crazy not to. They are fundamental camps and I don't trade based on fundamentals which tell you 'what should be happening' I trade based on the technicals which tell you 'what is actually happening'.

Right now the AUD/NZD currency pair is in a downtrend. The momentum is down. The tide is flowing away from Australia and towards New Zealand and I don't like to swim against the tide, any more than I like to trade against the trend. So for now we are headed towards parity and I am only looking for short trades on AUD/NZD until I see a change of trend.

That does not mean I am short by the way, nor does it mean I think it will actually hit parity. Only that right now the pressure is to the downside and to buy at this level in my opinion would be a risky move. Think trying to catch a falling knife.

When and if the tide turns, we will see money flowing out of NZD and back into AUD and this in turn results in a chart going from its current downtrend into an uptrend. Regardless of who thinks that a trend reversal 'should be' happening right now, the fact is it is 'not happening'. Not yet at least.

The Parity Trade - Why I hope it gets there

I love it when currencies hit parity, especially those times when it hits for the first time or the first time in a very long time. These can provide some exceptional trading opportunities.

Take USD/CAD for example, two countries that share a similar rivalry as Aussie and New Zealand do. When USD/CAD dips below 1.0000 that means a US Dollar is less than a Canadian Dollar. How much do you think Americans dislike that? How much do you think Canadians love it?

This creates a lot of anticipation of price movements at this very level and since the level of 1.0000 is so obvious and so precise, while been so widely watched and reported, there are a lot of orders placed there. Orders create price movement and parity levels have a lot of orders, thus creating a lot of potential trading opportunities.

Take AUD/USD as another good example. While the rivalry is not quite the same, the parity level holds true. When it reached parity in 2010, it touched it on the nose before declining 350 points in the next few weeks. That's the makings of a trading opportunity and I was trading that day, anticipating the level just like so many others. I had an alert set to go off and tell me exactly as parity was tested and I will have the same thing setup for AUD/NZD should it get much closer.

In summary, I don't have a crystal ball that can tell me if AUD/NZD will get to parity or not, I leave that task to the economists in camps 1 and 2. I can however tell you with a high degree of confidence that if it does get there, I am likely to be a buyer on the first test of 1.0000 as a lot of short trades get closed out (buy orders) as well as new buyers step into the market.

Whether we bounce right off parity or hang around it for a while does not matter, what matters is that parity levels provide good opportunities for those in the know and AUD/NZD is likely to be no different.