New Zealand dollar caught between safe-haven and EM status
This summer has seen a long-term bull market for the New Zealand dollar finally taper off as carry traders cash out of the Kiwi.
The Kiwi currency is the best G10 performer in the past 12 months against the dollar and euro, but US rate rises will dampen demand for the NZD by offering investors alternative sources of yield. Many traders have acted early and taken their NZD profits.
“In an environment where the US rates are rising and Treasury yields are rising, emerging markets (EM) currencies tend to struggle and the NZ dollar often gets caught up in that,” says Daragh Maher, currency strategist at HSBC. “It isn’t the most liquid currency and while it is a G10 currency, in times of risk aversion it can behave more like an EM currency.”
While there is a risk of the NZD getting caught up in another taper tantrum, that risk alone does not appear to explain the currency’s reversal of fortunes.
“This time I would expect the reaction to be more muted, now that the policy has been well flagged and the markets are expecting it,” says Adam Cole, global head of FX strategy at RBC Capital Markets.
Traders exiting their carry positions will have other factors in mind too. Geopolitical tensions such as those in Ukraine encourage repatriation of assets to safe havens like the US. The shale-gas revolution also makes the USD attractive relative to other currencies.
However, if investors can stomach global tensions, there will still be carry on offer holding NZD, in addition to any profit booked on currency appreciation.
And then there is New Zealand’s world-beating dairy industry.
“As the Chinese middle class has become relatively richer, their dietary preferences have changed in favour of dairy products, which dominate New Zealand exports,” says Adam Myers, European head of FX strategy at Crédit Agricole CIB.
A stronger NZD is typically negative for exports, but for dairy – its most important export – a stronger currency has less impact because it is a luxury good, with Chinese demand less sensitive to price rises. Even a Chinese slowdown might not undermine demand significantly.
“Consumer preferences often dominate other factors – for example, if milk is perceived to make your children taller,” says Myers. “So even if Chinese disposable incomes fall in the future, consumers may still decide to reduce spending in other areas before they cut back on milk.”
By contrast, Australian export markets are dominated by Chinese industrial demand for coal and iron ore, which are considerably more cyclical and easily drown competing soft commodity exports with New Zealand.
“In the 80s and 90s, global investors made little distinction between the Aussie and New Zealand dollars, but the rise of the Chinese consumer has encouraged them to increasingly differentiate between the two economies,” says Myers.
However, while soft commodities are less cyclical than industrial commodities, they are still exposed to some extent. The first declines in dairy prices seemed to make no difference to NZD, which continued to climb, but once the central bank the Reserve Bank of New Zealand (RBNZ) halted its rate hiking cycle to prevent the currency from strengthening further, the market took stock, causing a sell-off.
The increasing popularity of dairy is not only evident in China. Japan is also consuming more milk and cheese, and Japan’s recent sales tax and resulting slowdown might also have hurt New Zealand’s dairy exports and thereby been a drag on the NZD.
This is implied by the numbers, with New Zealand posting its worst trade-deficit numbers since August 2013. A seasonally adjusted deficit of NZD300 million helps explain the timing of the sell-off.
“When the carry unwinds, it tends to be the countries with the worst fundamentals that get hit first,” says Nick Beecroft, senior market analyst at Saxo Bank.
The reversal of NZD sentiment over the summer is also reflected in business confidence. ANZ’s New Zealand business confidence index dipped to 24.4 in August, its lowest level since 2012, and a sixth consecutive month of declines since it peaked at 70.8 in February.
However, New Zealand and its currency was coming off a strong run and the disappointing figures do not spell disaster. “The New Zealand economy is indisputably strong,” says HSBC’s Maher. “We saw GDP growth of 3.5% last year and the market expects close to 3% growth this year.”
It has benefited from long-term trends that should continue to influence currency markets, not only the strength of its dairy industry but the greater differentiation between the Australasian economies. This has encouraged FX investors, particularly long-term players such central banks and sovereign wealth funds, which previously might have only held AUD, to diversify into the kiwi.
According to an IMF survey of reserve managers conducted in 2013, more than 56% of central banks are considering diversifying the currency composition of their reserves, with the proportion higher for advanced economies than for middle- or low-income countries.
Of those that were interested in increasing diversification, nearly 75% said they would look at other advanced economy currencies such as the NZD, as well as CHF, AUD, CAD, DKK, NOK and SEK. Less than a third of respondents expressed an interest in diversifying into EM currencies.
Now all eyes are on the RBNZ in expectation of an eventual resumption of its rate hikes.
“If the RBNZ raises rates, that should strengthen the currency, cooling off exports and its related wealth-effect on the New Zealand economy,” says Crédit Agricole’s Myers. “But given the growing price insensitivity of foreign dairy demand, it may become more difficult to cool exports using the currency.
“In fact, this currency policy conundrum could attract more foreign investors. It’s a double whammy.”
|It all hinges on the China data,
which is often opaque and thus hard to read
This might well be the thinking behind the RBNZ’s pause in hikes, and nothing is expected to change imminently.
“The market is not aggressive in its expectations for rate hikes over the next 18 months,” says Maher.
Myers adds: “The key risk for New Zealand is that it may become a victim of its own success. Despite an attractive yield compared with other currencies, if only a small proportion of speculators conclude the NZD is unlikely to do as well in the next 12 months, or a faster rise in US rates affects their cost of funding, their cashing-in of positions could trigger panic selling of the currency, seeing perhaps a fall of up to 5% over the quarter.”
Even this shouldn’t spook the market excessively. The NZD trade-weighted index (TWI) can easily rise or fall 5% in a year, while quarterly NZD/USD moves of 10% to 15% versus are not uncommon.
“We are still close to those record highs witnessed last month, and both the RBNZ and government are probably hoping the NZD TWI will fall from here to take pressure off exports,” says Myers. “It has been clear it will intervene should the currency get too far out of line with fundamentals.
“It all hinges on the China data, which is often opaque and thus hard to read. If we see a strong rebound in China, particularly from the consumer, then that should mean further NZD appreciation. If China fails to rise strongly, the now crowded NZD speculative trade should reduce, taking some steam out of NZD gains. Our expectation is for Chinese growth to come in lower and for a cooling of NZD.”
Saxo’s Beecroft agrees, saying: “It wouldn’t be surprising to see the NZD decline to around 0.8 against USD by the end of the year, but that would probably be a good level at which to start buying it.”
RBC’s Cole adds: “We are less bullish than we were on NZD, but we aren’t bearish,” says Cole. “We expect it to trade within a range for the foreseeable future at between 82 to 86 against the USD.”