Kiwi Correction On The Cards In 2014

Short-Term Outlook:

The New Zealand dollar has had a great run since early September on the back of improving global risk sentiment, and the upswing in speculative positioning suggests that there is potential for further near-term gains. Indeed, we believe that there is room for another leg up for the kiwi, although we expect that potential resistance in the region of US$0.8600-0.8800/NZD will prove difficult to overcome. Looking further ahead, any additional short-term strength will eventually give way to the fundamental downside pressures that remain firmly in place.

Core View:

How Long Will Positive Sentiment Last?
New Zealand - Exchange Rate, US$/NZD
BMI NEW ZEALAND CURRENCY FORECAST
Spot Short-Term Ave-14 Ave-15
US$/NZD 0.8441 - 0.7500 0.7100
NZD/EUR 0.6120 - 0.5906 0.5772
Policy Rate (%) 2.50 - 2.50 2.75
Source: BMI, 24 October 2013

Short-Term Outlook:

The New Zealand dollar has had a great run since early September on the back of improving global risk sentiment, and the upswing in speculative positioning suggests that there is potential for further near-term gains. Indeed, we believe that there is room for another leg up for the kiwi, although we expect that potential resistance in the region of US$0.8600-0.8800/NZD will prove difficult to overcome. Looking further ahead, any additional short-term strength will eventually give way to the fundamental downside pressures that remain firmly in place.

How Long Will Positive Sentiment Last?
New Zealand - Exchange Rate, US$/NZD

Core View:

Despite room for short-term strength, limited improvements in New Zealand's external indebtedness suggest that the currency remains expensive at current levels and vulnerable to capital flight. As such, we expect a correction to occur in the medium term, and forecast the currency to average around US$0.7500/NZD in 2014, after trading around US$0.8100/NZD in 2013. In real effective exchange rate terms, the New Zealand dollar is currently almost as expensive as it was back at the peak of 2011. Indeed, the current run-up shares a number of similarities to the H111 rally especially given the string of positive data releases from Chinese and Australian economies both in 2011 and, more recently, in Q313. However, we note that back then, the positive news was followed by a sharp reversal in fortunes, as imbalances in China and Australia came to the fore, which ultimately weighed on the New Zealand economy. Despite the recent spate of good news, such vulnerabilities still persist today, meaning that the New Zealand dollar remains susceptible to a material correction. Indeed, although the New Zealand economy has seen a reduction in its reliance on Australia ( see 'Risks Remain Despite Reduced Australian Exposure', September 6), the two economies remain intricately connected and we believe that the New Zealand economy will eventually succumb to a relapse in both Australian and Chinese business cycles in 2014.

Unsustainable Highs
New Zealand - NZD Real Effective Exchange Rate Index

Moreover, we maintain our view that the Reserve Bank of New Zealand (RBNZ) will maintain its policy rate at an all-time low of 2.50%, compared to a 25 basis points (bps) hike implied by the short-term forward rate market. Given that domestic business credit has only just begun to show signs of life, with growth breaching through 2.0% year-on-year (y-o-y) in August for the first time since the start of 2013, we expect the monetary authorities to be less willing to choke off a still-fragile credit story. Narrowing spreads between the New Zealand and US 10-year government bonds also suggests that market expectations are starting to turn. As opposed to hiking interest rates, we expect the central bank to implement further macro-prudential rules to rein in housing demand. We believe that these further changes will weigh on the profitability and funding requirements of New Zealand financial institutions, which will likely exacerbate any depreciatory pressures on the currency in the medium term.

Further Declines Likely
New Zealand - Net International Investment Position, Total & Banking Sector (NZDmn, LHS Inverted) And As A Share of Total (%, RHS)

Apart from these factors, New Zealand remains among the most highly indebted countries in the world, alongside countries such as Hungary, Portugal, Greece and Spain, with a net international investment deficit hovering above 70% of GDP (as of Q213). Indeed, the high level of external indebtedness increases the vulnerability of the currency to global shocks, on top of any domestic economic turbulence that might weigh on it. Given that portfolio liabilities are more than a third of the 155.5% of GDP external liabilities that New Zealand owes, we believe that the risk of capital flight remains acute for the New Zealand dollar.

Risks To Outlook:

Although we believe that subdued economic growth and a slowdown in house price growth in the coming quarters will keep interest rate hikes off the table, political pressure to rein in real estate prices given the upcoming elections in 2014 and financial stability concerns could tip the scales. Given a global climate of near zero interest rates in the developed world, as well as market expectations for the new US Federal Reserve governor, Janet Yellen, to pursue a dovish approach, a rate hike could increase the attractiveness of New Zealand dollar-denominated, short-term money market instruments and debt. This would lead to further unsustainable widening of the country's external indebtedness while the kiwi faces greater appreciatory pressure.

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This article is tagged to:
Sector: Country Risk
Geography: New Zealand
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