Hedge funds had placed a massive bet against the New Zealand dollar. But a surprise manufacturing boom turned that bet upside down.
The Reserve Bank of New Zealand had kept its key interest rate unchanged for three years before this week's hike, maintaining a loose policy stance through the pandemic recovery. That decision, combined with upward momentum in activity data, has reinforced expectations of further rate increases.
That report followed closely on the heels of the RBNZ's first rate increase in three years.
The combination of a rate hike and strong growth has traders betting on more tightening. Market participants in the swaps market now expect roughly two more quarter-point increases from the central bank before the year ends.
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The two-year government bond yield, representing investor returns, climbed roughly 20 basis points in July to 3.50%. That is the highest level in a month.
Andrew Hazlett, a currency trader at Monex Inc., commented, "The hawkish pivot from the RBNZ has given good support to the kiwi. "If further hikes materialize, then we would expect further strengthening towards end of the year"."
The CFTC data revealing US$1.5 billion in short positions highlights the scale of bearish bets that were caught off guard. Such extreme positioning often leads to sharp reversals when fundamentals shift, as seen with the kiwi's rally. Analysts note that the unwinding of these shorts could provide additional upward momentum in the coming weeks.
The concentration of bearish bets left the kiwi vulnerable to a sharp rally when positive news emerged. Traders who had borrowed NZD to sell short were forced to buy back the currency, amplifying the upward move. Such short squeezes can sustain momentum for weeks as remaining shorts cover positions.
Analysts say the New Zealand dollar could keep rising for several weeks. "Kiwi's strength will last for some weeks as market positioning is too negative," noted a strategist at Wells Fargo, Erik Nelson. These funds have maintained short positions on the kiwi since December.
Neil Jones, managing director at TJM FX, suggests using options to buy the NZ dollar against its Australian counterpart, explaining that "the Reserve Bank of Australia hiking cycle appears largely complete, while the Reserve Bank of New Zealand has reintroduced the possibility of further tightening."
If the RBNZ delivers more rate hikes as traders expect, the kiwi could strengthen further against the US dollar and other currencies. The recent policy shift marks a turning point for the New Zealand dollar, which had been under pressure from prolonged low rates. With the RBNZ now signaling further tightening, the currency's outlook has improved significantly relative to other major currencies, particularly the Australian dollar where the hiking cycle is seen as complete.
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