The New Zealand Dollar Faces a Long Road to Recovery 

Image © Rafael Ben-Ari, Adobe Images

- NZD to rise Thursday as USD retreats further says Westpac. 

- Kiwi will gain steadily in 2019 say analysts at MUFG and CBA.

- But recovery will be modest as risks and headwinds abound.

The New Zealand Dollar is set for gains on Thursday and should regain at least some of last year's loss over the course of 2019, according to multiple analysts, although it will be a long road to recovery. 

Chinese officials said Thursday that talks with U.S. counterparts have laid "the foundation for resolving issues" around international trade over the coming weeks, delivering a boost to investor risk appetite at a time when markets are on edge over the so-called trade war between the world's two largest economies.

As a "risk" asset the Kiwi currency benefited from this optimistic take on the trade talks, although it had made a good start to the year anyway, rising against the U.S. Dollar and around half of the G10 currency basket as markets continue to position for a landmark shift in the global interest rate environment during the months ahead. 

"There is potential for further gains above 0.6800, as the US dollar is weaker, and risk sentiment is upbeat," says Tim Riddell, a macro strategist at Westpac, of the Kiwi outlook for Thursday. 

The Federal Reserve (Fed) and U.S. Dollar have fallen firmly from favour with the market this January as investors are openly speculating that the world's largest economy will slow this year, forcing its central bank to the sidelines and undermining the currency. 

This on its own implies a certain amount of upside for other currencies relative to the Dollar, including for the Kiwi, which is why some analysts are projecting gains for the Antipodean unit in 2019 even though they also forecast slower growth continued record low interest rates. 

"Our view of a more cautious Fed in 2019 implies less cyclical support for the dollar generally, which reinforces our view of further modest NZD appreciation this year. Appreciation is likely to be modest given the RBNZ could well remain on hold throughout all of this year – but this view is already consistent with market pricing," says Derek Halpenny, European head of research at MUFG.

U.S policymakers used a Federal Open Market Committee dot-plot and that month's policy statement to signal that they will be slower raising interest rates this year, which was perceived as a death knell for the days of U.S. economic exceptionalism.

That exceptionalism had boosted the Dollar in 2018 because it enabled the Fed to raise rates four times last year as economies elsewhere slowed and the respective central banks stood pat. But speculation of a pause in the cycle is now intensifying.

Above: NZD/USD rate shown at daily intervals.

Halpenny and the MUFG team say this kind of market environment can drive the Kiwi Dollar steadily back up to 0.71 over the course of the year, which would reverse almost all of 2018's annual loss. 

However, they also say the Kiwi will cede ground to Sterling once uncertainty over the outcome of the Brexit process is removed. This will lead the Pound-to-New-Zealand-Dollar rate to rise from 1.88 to 2.02 by year-end.

Above: Pound-to-New-Zealand-Dollar rate  shown at daily intervals.

Commonwealth Bank of Australia (CBA) said Thursday that it also expects some "modest" appreaciation of the Kiwi this year, although the bank's forecasts suggest that gains will be very limited. 

And on the downside for buyers of the New Zealand Dollar, the Pound-to-Kiwi rate is projected to remain stable around its current level throughout the next 12 months.

"NZD/USD is set to lift modestly over 2019 for five reasons," says Richard Grace, head of currency strategy at CBA. 

Steady economic growth, firm commodity prices and "solid demand" for New Zealand Dollar assets by foreign central banks and other money managers are all expected to support the Kiwi currency this year. 

However, the pace of gains will be slow for the Kiwi mainly because the U.S. Dollar will only decline very modestly, according to CBA. The bank's analysts say that economic growth will also slow in Europe, China, Japan and the UK this year so the performance of the respective currencies will be uninspiring. 

"It is difficult to envisage the USD depreciating much against the currencies of these economies until their economic growth regains traction in H2 2019," Grace writes, in a note to clients Thursday. 

New Zealand's economy grew by just 0.3% during the third quarter, down from 1% previously, which was enough to drag the annual pace of growth down to 2.6% from a revised 3.2% for the second quarter.

The jury will deliberate on the likely pace of growth in the final months of the year until March 2019 when the data is released and a pick-up from the dire number published for the third quarter iwill be necessary to prevent the market speculating about a possible Reserve Bank of New Zealand (RBNZ) interest rate cut over the coming months. 

RBNZ officials said in July and August last year that it would cut the cash rate ifthe growth outlook does not improve during the second half of the year. The bank has held its cash rate at a record low of 1.75% ever since November 2016.

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