BNY Mellon: The Aerial View: Meanwhile in New Zealand

October 11, 2018

By Neil Mellor, Senior Currency Strategist, BNY Mellon

While the IMF has upgraded its growth forecasts for New Zealand, the fund’s downbeat take on the global economy is ample compensation for NZD bears.

Like the AUD, the NZD has ceded just under one-tenth of its value to the USD this year due partly to its status as a commodity currency sensitive to global demand and at a time of growing pressure on emerging markets.

China – the driving force behind global commodity prices and lodestar of the emerging sector - not only accounts for 15% of New Zealand’s exports, but it is also the main market for the principal produce of Australia, New Zealand’s second largest trading partner.

Hence, China’s importance to New Zealand makes news of its slowing performance a boon to Kiwi bears, and as we argued yesterday, there are certainly reasons to believe that China may well be prepared to manage a modest weakening in its currency with inevitable repercussions for its trade partners.

But the Kiwi’s woes are not entirely the product of external factors. By far the biggest move this year (-2.0%) came on August 9 as the Reserve Bank of New Zealand (RBNZ) unveiled a surprise deferral of an OCR hike widely penciled-in for 2019 and alluded to the growing possibility of rates being cut.

Like many a central bank, the RBNZ has struggled with low price pressures. At 1.5%, annual inflation remains below the mid-point of the Bank’s 1-3% target range, and the rate is only just expected to sneak over the line in 2021.

Since the RBNZ produced these forecasts, however, GDP growth has exceeded the Bank’s forecasts by a factor of two - belying some downbeat confidence reports in doing so – and there is also evidence of price pressures picking up, all of which may be more fully reflected in the Bank’s next Monetary Statement on November 8.

But while the Bank has only limited latitude for any economic deviation from its course, there may be little incentive for it to risk any modification to its cautious language.

And as RBNZ policy is instrumental in the 50 bp premium that 10-year US Treasuries now offer investors over equivalent Kiwi bonds, the NZD’s upside appears fairly limited. It is certainly unwanted.

Indeed, the Kiwi’s slide against the USD has served as a welcome offset to downward pressure on commodity prices: dairy prices fell by 11.5% y/y at the last GlobalDairyTrade auction (whilst there is more pressure in the pipeline). And there can be little suggestion that the Bank will be overly perturbed with the extent of the Kiwi’s slide.

The NZD’s performance is only mentioned in matter-of-fact terms in the Monetary Policy Statement and understandably so perhaps, given that the trade-weighted NZD is still 8% higher than where it began the decade.

Besides, there is little evidence that NZD/USD is particularly undervalued, whether we consider New Zealand’s sizable current account deficit (3.3% of GDP), average spot rates of 0.67 for the millennium (and 63 cents post-float) or the OECD’s PPP rate of 0.68.

As ever, skewed positioning is always a potential banana skin for the market (CFTC data points to record shorts)