New Zealand Dollar Outperforms after Credit Rating Outlook Improves, Potential for More Gains Ahead

Image © Rafael Ben-Ari, Adobe Images

- NZD supported Friday as S&P's says credit outlook has improved. 

- Upgrade eases fears for economy, NZD advances as others fall.

- CBA and Westpac forecast further gains ahead for the NZD.

The New Zealand Dollar held its own against a recovering U.S. Dollar Friday as the Kiwi currency was supported by an upgrade to the government's credit rating outlook, which may have eased investor fears about the economy.

Standard & Poor's reaffirmed New Zealand's AA+ sovereign credit rating late Thursday and upgraded the outlook from stable to positive, citing an anticipated improvement in the public finances that could erase the budget deficit and provide the government with a surplus before the end of 2020. 

"The upgrade likely reflects a number of factors including, a series of actual (and forecast) government budget surpluses (OBEGAL), lower government net debt as a % of GDP, and RBNZ regulations to further strengthen the banking system. This change to the sovereign outlook reflects a 33% chance of an actual upgrade over the next 2 years," says Joseph Capurso, a currency strategist at Commonwealth Bank of Australia.

Fears over the outlook for the Kiwi economy have hurt the New Zealand Dollar during recent moths, amid the U.S. trade war with China and an uncertain outlook for global growth and commodity prices. 

This has seen markets increasingly speculating that the Reserve Bank of New Zealand (RBNZ) could be forced to cut its interest rate later this year, which would support growth and thereby give the bank more chance of lifting inflation into the upper end of the 1%-to-3% target band.

Given that downbeat backdrop, S&P's upgrade was taken this week as a vote of confidence in the Kiwi Dollar outlook, enabling the currency to hold its ground against the U.S. Dollar even as others handed earlier gains back to the greenback. 

"Supportive factors near term include the Fed’s recent dovish shift, strong equity markets in January, higher dairy prices, and a sovereign ratings outlook upgrade from S&P. Beyond 0.6970, the next technical target is 0.7060 – the June 2018 high and also a classical 62% retracement of the major 2018 decline," says Imre Speizer, head of NZ strategy at Westpac. 

New Zealand's economy grew at its slowest quarterly pace for three years during the third-quarter according to official data, with the annualised rate of growth falling from 3.2% to 2.6%, which was beneath the forecast of the RBNZ for this time period. 

Interest rate derivative markets show investors are betting a near-50% chance the RBNZ will cut its cash rate to a fresh record low of 1.5% before February 2020. The market-implied interest rate for that month was 1.68% on Tuesday, around half a rate step below the current 1.75% level.

Kiwi inflation has been beneath the midpoint of the RBNZ target for almost four years, prompting the bank to keep its interest rate at a record low of 1.75% for more than two years. And now both the global and New Zealand economies are slowing, which means even less inflation pressure in the future.

"US-China talks finished with a generally optimistic tone though not much substance at this stage beyond a roadmap. Lighthizer-Mnuchin are expected to visit Beijing in mid-Feb for continued talks. The talks included a new offer from China to buy more soybeans though soy futures don’t show any dramatic change in sentiment," says Elsa Lignos, head of FX strategy at RBC Capital Markets.

Friday's resilient performance from the New Zealand Dollar came even in the face of fresh signs the Chinese economy is under pressure from President Donald Trump's trade tariffs, with the Caixin manufacturing PMI falling deeper into contraction territory during January, suggesting the sector is now in recession.

Negotiators from the U.S. and China are attempting to reach a deal that ends the tariff fight between them before a March 01 deadline that will see the 10% tariff levied by the White House on annual imports from China of some £200 billion worth of goods automatically rise to 25%.

This is important for the Kiwi because China is New Zealand's largest trade partner although the products bought by the world's second largest economy are mainly agricultural ones, such as milk powder and other dairy items. 

"NZD/USD has scope to edge higher. New Zealand's economy has been a large recipient of increased bond inflows, and more recently, increased equity inflows, since the 2008‑09 GFC. This trend of capital inflows will support NZDappreciation, particularly at a time when New Zealand's terms of trade is near record highs, and the USD is softening as the Fed indicates it is being patient to assess the next direction on interest rates," says CBA's Capurso.

The NZD/USD rate was quoted 0.01% higher at 0.6915 Friday and has now risen 3% thus far in 2019, making it the second best performing G10 currency relative to the greenback, behind only the Canadian Dollar. 

The Pound-to-New-Zealand-Dollar rate was -0.07% lower at 1.8948 and has risen just 0.02% so far in the 2019 year. New Zealand's currency was up against all of its G10 rivals Friday.

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