Investors have been shorting the New Zealand dollar against the U.S. dollar via forwards over recent days as a hedge against flatteners on the New Zealand rates curve. This strategy has received increased interest since talk of tapering the U.S. bond buying program began and some emerging market funds were deploying the strategy prior to the Kiwi spurt. Now investors are looking at other overvalued G10 currencies.
Fx can be used as a hedge because when the [U.S. Federal Reserve] tightens, curves in EM or NZ steepen and USD rises, Sebastien Galy, currency strategist at Société Générale in New York, told DW. If you have flatteners but cant sell because the position is illiquid then you gain from the short NZD/USD.
Galy noted that large bearish short NZD positions drive up the demand for front-end borrowing in the New Zealand curve. Most flatteners are on the 2s5s and 2s10s, according to market participants. This fx positioning may well be a hedge taken by fixed income investors in the NZ curve, as it would have been extremely difficult for them to reduce their carry [flatteners], Galy added.
One senior fx and rates strategist in New York noted that since the tapering story started currencies sold off and curves steepened strongly. However, two weeks ago curves began to flatten with most currencies rallying. Rather than unwinding the flattener or protection in rates people rather short the currency in case tapering talks materialize as the market in fx tends to be more liquid, said the strategist.
It is worth noting that investors have been net short NZD for the last three weeks--currently -8% as percentage of open interest. The last time investors were net short was in June 2012, wrote strategists at Deutsche Bank, in a client note.
NZD/USD spot was USD0.7904 Wednesday afternoon in New York.