Buy Australian Dollar Calls Versus New Zealand Dollar, RBC Says

By Ron Harui

Aug. 21 (Bloomberg) -- Investors should buy three-month call options on Australia's dollar against New Zealand's as traders ``underestimate'' the amount of interest-rate cuts by the Reserve Bank of New Zealand, said RBC Capital Markets.

New Zealand's dollar is likely to fall 8.7 percent to NZ$1.33 versus Australia's by year-end as the nation's economic slowdown accelerates, boosting prospects the RBNZ will lower borrowing costs by as much as half a percentage point in September or October, according to RBC. Traders are betting the RBNZ will reduce rates by 25 basis points next month, a Credit Suisse Group index based on overnight swaps shows.

``Rapidly declining growth and the risk of an extended recession in New Zealand does mean the risk of a greater than 25 basis-point cut at one of those meetings is quite high,'' Sue Trinh, senior currency strategist in Sydney at RBC Capital Markets, said in an interview, confirming a client note dated yesterday. ``The market continues to underestimate that risk.''

The New Zealand dollar traded at NZ$1.2229 versus Australia's dollar at 3:22 p.m. in Wellington, from NZ$1.2239 late in Asia yesterday. The currency, known as the kiwi, reached NZ$1.2969 on July 24, the lowest since November 2000.

Investors should purchase Australian dollar call options expiring on Nov. 24 at a strike price of NZ$1.28, Trinh wrote in the client note. They should also sell call options maturing on the same date at a strike price of NZ$1.33, to reduce the cost of the bet, she said.

Call options give the buyer the right -- but not the obligation -- to buy an asset at a pre-agreed price on a set date. By selling a call option, the investor is taking a bet the contract won't be exercised, allowing them to keep as profit the premium paid for the option.

Call Spreads

The so-called call spread yields a profit of as much as NZ$0.05, before the 0.35 percent purchase cost of the contract is deducted, should New Zealand's dollar reach NZ$1.33 against Australia's dollar by the Nov. 24 expiration date, according to Trinh. Call spreads are only profitable as long as the currency moves within a specific range.

Traders are betting the RBNZ will cut its 8 percent official cash rate by 1.48 percentage points over the next 12 months, and the Reserve Bank of Australia will reduce its 7.25 percent benchmark rate by 1.04 percentage points within the next year, according to Credit Suisse indexes based on rate swaps.

Against the U.S. currency, New Zealand's dollar rose to 71.34 U.S. cents from 70.99 cents and the Australian dollar climbed to 87.29 U.S. cents from 86.90 late in Asia yesterday.

Currency Forecasts

RBC Capital Markets, a unit of Canada's largest bank, expects the kiwi to weaken to 69 cents by year-end as New Zealand's economy contracts. A government report last week showed retail sales fell by the most in at least 13 years in the second quarter, adding to evidence the economy sank into a recession in the first half of the year.

RBC also forecasts Australia's dollar, known as the Aussie, will rise to 92 cents by year-end, Trinh said.

The forecast is ``based on the fact that a lot of the decline in Aussie to date has been predicated on the RBA easing cycle and been built into the price'' of the Australian currency, she said.

The RBA will probably lower borrowing costs by a total of 50 basis points, or 0.50 percentage point, this year, Trinh said.

To contact the reporter on this story: Ron Harui in Singapore at rharui@bloomberg.net