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Currency Forecast
NZD/USD Outlook
After rallying over 80 percent in the past four years and becoming one of the darlings of the currency market, the impressive run in the NZD/USD looks to have now come to an end in the first quarter of 2006. In fact, since the beginning of the year, the New Zealand dollar has fallen 14 percent or 1000 pips against the US dollar. Carry trade liquidation hit the kiwi hard, which sold off not only against the US dollar, but also against the Japanese yen. This is a perfect reason why having one of the highest interest rates in the world is not good enough. The NZDs performance this year proves to carry traders that they need to focus on growing interest rates rather than the absolute value of the interest rate. The Reserve Bank of New Zealand has left interest rates unchanged since 2005, but what really sparked the Kiwi dollars fall this year were comments from RBNZ Governor Bollard in February. He said that he would be comfortable with a slide in the currency, which served as his endorsement for weakness.
Major Liquidation of Carry Trades
Carry trades have been one of the most popular trading strategies used by hedge funds and individuals over the past few years, and the New Zealand dollar was probably the most popular carry trade currency of them all. With the highest interest rate of any nation that has ratings agency Moodys top credit rating, it is no wonder why money poured into Kiwi denominated investments. This even raised the popularity of Uridashi bonds, which in this case were New Zealand bonds sold in Japan. Japanese investors were faced with near zero interest rates back home, so their appetite for foreign bonds was the biggest. This made NZD/JPY not only a popular trade for Japanese investors, but also for foreign investors. Therefore in the first quarter, with the prospects of higher interest rates in Japan and signs of weakness in New Zealand prompting talk of an interest rate cut, traders that were long NZD/JPY for carry headed for the exit. By the same token, there were also many investors long NZD against the US dollar for carry, but with the US also aggressively raising interest rates while New Zealand stood firm,, the shift in tone by the RBNZ, gave NZD/USD bulls a good reason to exit out of their own carry trades as well.
Data Takes a Big Hit but Things Could be Turning
The massive exodus out of long Kiwi carry trades stemmed from the fact that the currencys strength over the past few years has finally had a pronounced impact on growth. GDP contracted in the fourth quarter by 0.1 percent for the first time in five years after having only grown 0.1 percent in the third quarter. As an export dependent country, the 21 year high in the currency has crimped foreign demand and hurt investment. This will keep the central bank on hold for at least the next few months until we see more signs of a recovery in the economy. Many analysts predict little to no growth for the next few quarters unless the central bank cuts interest rates. Governor Bollard, however, said on March 9th that unless domestic demand also slows, he is unlikely to lower interest rates since inflation still remains above the central banks 3 percent pain threshold. With economic growth weak; the RBNZ remaining on hold at a time when the US continues to raise interest rates; and the Bank of Japan looking for the right time to drop their zero interest rate policy, New Zealand will find themselves left behind. Their lag in growth should continue to keep the Kiwi dollar under pressure.
Depreciation in Currency Will Boost Growth
Even though the demise of the Kiwi came from the central banks concern for growth, the same depreciation could also be what saves the countrys economy as well. The 14 percent slide in the New Zealand dollar works to combat the tighter monetary conditions presented by the high level of interest rates. As an export dependent economy, the weakness of the Kiwi naturally makes New Zealand exports more competitive once again. We have already seen a tick up in the latest Purchasing Managers Index for the month of March, which rose from 51.2 to 53.3. Additionally, the latest retail sales figures for February have shown the biggest gain in two years. This indicates that domestic demand is strong, which is extremely important since consumer spending makes up 60 percent of the $97 billion economy. Should the export sector rebound as well thanks to the weaker Kiwi, then the country will see growth from both domestic and external demand. However, before getting too excited, it seems that the strength in February could have been largely due to sales being flat in January, which means that we need to see the figure for March to get a better gauge of whether domestic demand is really experiencing a concerted rebound. If so, 0.60 may have been the bottom in the NZD/USD.
AUD NZD Decoupling
Another interesting development is the decoupling between the Australian dollar and the New Zealand dollar. Traditionally, both of the currencies have had a very strong positive correlation of upwards of 80 percent. However, over the past quarter, the relationship has broken down significantly. The Australian dollar has been lifted higher by rising gold prices. As one of the worlds largest producers of gold, Australia stands to benefit significantly from appreciation of the yellow metal. New Zealand, on the other hand, which traditionally also had an extremely positive correlation with gold, came under extreme pressure following weak economic data and comments from Bollard. On top of that, New Zealand is not a producer of gold which means that their previous correlation has been due to its sensitivity to growth in Australia, its largest export market in addition to the fact that both central banks were pretty much in sync with their monetary policies. The trade relationship should hold the test of time as there is no reason why Australias demand for New Zealand exports should change anytime soon. The monetary policy direction, however, could remain different for some time as growth accelerates quicker in Australia. Therefore, even though the correlation between the two currencies is expected to resume once again, when it does, it may not be as strong as it was before.
Conclusion
The New Zealand dollar is expected to remain under pressure for the next few months as central bank Governor Bollard continues to jawbone the currency in order to spur growth. Given the state of domestic demand, Bollard has shown no intentions of lowering interest rates, which means that if economic data continues to improve thanks to the weakness of the currency, we could see a mild boost in the NZD/USD. However, as the currency appreciates, its benefit to the economy decreases, which means that if we get back towards 65 cents, data could begin to surprise to downside. The real wild card rests not with New Zealand, but with the US Federal Reserve and the Bank of Japan. When the Fed signals the end of their tightening cycle, we could see broad based dollar weakness that brings the NZD/USD pair higher. When the BoJ begins to raise interest rates, we could see broad based yen strength that takes the NZD/JPY currency pair lower. However, neither of these scenarios is expected to happen until the third or fourth quarter at the earliest, which means that for the time being, Kiwi weakness should still be dominant.
Technical Outlook
The New Zealand dollar broke a very important long term trendline at the beginning of the year. Although the currency continued to trade close to the trendline around the 0.6700 level, the break should have been the first sign to traders that the currency pair was losing momentum. The downtrend has been very strong with perfect order moving averages and MACD in deep negative territory. Despite the clear weakness, however, we are currently seeing signs of a possible bottom with 3 weeks of the price making higher highs and higher lows. In addition, prices are stalling at a very critical support level served not only by the psychologically important 0.6000 price point, but also the lows dating back from May 2004 and the 38.2 percent Fibonacci retracement of the 0.3895 October 2000 low and the 0.7470 March 2005 high. Therefore, if prices continue to hold at current levels, we could see a retracement back towards the former breakout point around 0.6625. If, however, the most recent swing low of 0.5990 is broken, the door is open for a continued break all the way down to 0.5700, which is the 50 percent Fibo of the same long-term move.
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