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Foreign Exchange

New Zealand dollar on verge of safe-haven status, says UBS

A small, open, export-driven economy with limited natural resources and a population still recovering from two devastating earthquakes are hardly the defining characteristics of a safe-haven currency. But, for the second-best-performing G10 currency this year, the New Zealand dollar, it may become just that, according to a research note published by UBS.

The kiwi has long been a favoured currency pair for the carry trade due to its relatively high interest rates, and its recent outperformance has been driven by increased interest-rate expectations, with a rise anticipated for 2012, says UBS analyst Chris Walker. That’s a reversal of expectations after the Royal Bank of New Zealand cut the benchmark rate in March in the wake of the Christchurch earthquake. However, the rise and rise of the New Zealand dollar isn’t just about the carry trade, the report says.

UBS conducted an analysis in which it plotted G10 currency betas to Standard & Poor’s S&P500 index (a measure of risk), relative to 10-year bond yields for the year to date. If yields were the only motive for buying a currency pair, the ratio between the currency beta and 10-year yields would remain constant, the report says. However, the results of the analysis show that this isn’t the case. Indeed, they indicate that in reference to the kiwi, higher-yielding returns are not being offset by a higher risk metric.


Ratio of beta to S&P 500 vs 10 year government bond yield 
 
 Source: UBS FX Strategy, Bloomberg

To be sure, the New Zealand dollar isn’t a safe haven in the same context as the Swiss franc, US dollar and yen, the UBS analysis shows, but it outperforms the Nordic currencies as well as the Canadian dollar and the euro, by that measure. Furthermore, the kiwi is likely to remain underpinned by the repatriation of insurance claims by non-resident reinsurers, says Walker. According to RBNZ estimates, claims on these reinsurers total about NZ$11 billion ($9.4 billion) from the September 2010 and February 2011 earthquakes. Given the limited liquidity sources in the New Zealand dollar, that is likely to have a large influence on future price action (see chart).


Potential re-insurance flows are significant for NZD 
 
 Source: RBNZ, AIR Worldwide, BIS

Separate to the UBS report, some New Zealand dollar traders who spoke to EuromoneyFXnews estimate that some 75% of those claims have already been repatriated.

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