Major Weakness Ahead Across The Board

Short-Term Outlook

The NZD looks to be forming a topping pattern which should give way to severe weakness in line with what we have seen in other commodity currencies in recent quarters. Stiff resistance stands at US$0.8500/NZD, which we expect to hold, while a break below US$0.8100/NZD would likely trigger intense selling pressure.

Core View

Impressive Run Nearing An End
New Zealand - NZD Trade Weighted Indices
BMI NEW ZEALAND CURRENCY FORECAST
Spot Short-Term Ave-14 Ave-15
US$/NZD 0.8325 - 0.7500 0.7100
NZD/EUR 0.6110 - 0.5906 0.5772
Policy Rate (%) 2.50 - 2.75 2.75
Source: BMI, 16 January 2014

Short-Term Outlook

The NZD looks to be forming a topping pattern which should give way to severe weakness in line with what we have seen in other commodity currencies in recent quarters. Stiff resistance stands at US$0.8500/NZD, which we expect to hold, while a break below US$0.8100/NZD would likely trigger intense selling pressure.

Impressive Run Nearing An End
New Zealand - NZD Trade Weighted Indices

Core View

The New Zealand dollar seemingly defied gravity in 2013. While it's Australian counterpart was one of the worst performing currencies in the world in total return terms (fifth worst out of all the expanded majors candidates on Bloomberg), the New Zealand dollar was among the top performers. Against the Canadian dollar, too, with which it usually tends very closely, the kiwi has significantly outperformed. Both the NZD/CAD and NZD/AUD cross rates are back to 2005 levels. A similar story holds true for the kiwi's performance against other commodity currencies such as the NOK and the BRL. Taking into account inflation differentials, the currency is now the strongest it has ever been in real effective terms.

What Is Driving Kiwi Strength?

Export performance does not seem to explain the relatively strong performance of the NZD over the past year. Indeed, New Zealand's exports have actually performed worse than those of Australia over the past 12 months. In a related fashion, New Zealand's current account deficit is larger than its Australian and Canadian peers, and in fact is among the largest in the developed world.

It is clear, therefore, that the appreciatory pressure on the kiwi is coming from the financial account side, and this is largely being driven by expectations that the Reserve Bank of New Zealand will begin its hiking cycle in the near term. Forward rate agreements are pricing in more than 100 basis points (bps) of interest rate hikes by the end of 2014. The rate markets may be proven correct in the near term, and we indeed expect the RBNZ to tighten interest rates to 25 basis points in Q214. The housing market continues to boom, and the credit cycle is once again on the upswing, while the RBZN has signalled that it will likely tighten rates in the near term.

Current Account Deficit Leaves Kiwi Exposed
New Zealand - Current Account, % of GDP

However, we do not believe that that current recovery is sustainable. Household credit has been responsible for the entire increase in private sector credit since over the past two years, and the ratio of household to business credit now stands at a record 2.5 times. While the New Zealand government has made some progress regarding curtailing expenditure growth and boosting aggregate savings, the country is by no means entering a structural growth boom of the kind that would warrant such a strong currency, in our view. Rather, this current upswing is likely cyclical in nature, and will come under pressure once again as higher interest rates dampen the demand for credit. As it becomes clear to investors that New Zealand interest rates are set to remain low for an extended period, the appeal of the currency from an investment perspective is set to diminish, exposing the wide current account deficit and triggering steep decline in the NZD.

We are forecasting the NZD to decline from its current level of US$0.8325/NZD to US$0.7300/NZD by end-2104, and expect it to average US$0.7500/NZD. Declines should continue into 2015, when we expect the unit to average US$0.7100/NZD and end the year at US$0.6900/NZD.

Risks To Outlook

The two main risks to our bearish view come from a collapse in the US dollar and a continued recovery in the New Zealand economy. While not our core view, any renewed weakness in the US economy could see tapering expectations pushed back and lead to weakness in the greenback. Domestically, should we begin to see signs that business credit is taking off in New Zealand and the current account deficit is narrowing, this would be supportive of continued strength in the currency. That said, at current levels, upside risks, even in the most bullish scenario, are very limited in our view.

Read the full article

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

Enter your details to read the full article

By submitting this form you are acknowledging that you have read and understood our Privacy Policy.