New Zealand Dollar Falters as Virus Fears Wash Away Demand for NZ Bonds, but Downside Seen as Limited

- NZD slips as European virus fears overwhelm demand for NZ bonds.
- After RBNZ policy, economy, finances drive demand for NZ Gov debt.
- But superior virus containment, better finances to limit NZD downside.

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The New Zealand Dollar faltered on Wednesday, as a tide of risk aversion swept across global markets, washing away support that had resulted from strong international demand for new Kiwi government bonds, although some analysts say the currency’s downside should be limited.

Risk currencies like the Kiwi were on the back foot while safe-havens like the Japanese Yen and U.S. Dollar were in demand as Europe appeared to lurch again toward another ‘lockdown.’ 

Germany is said to be contemplating the closure of bars from November 04, French officials are reported to be advocating that the government impose another all out shutdown.

Above: Worldometers graph showing coronavirus infections detected and disclosed each day in U.S. Vs Europe.

Meanwhile, the UK government’s advisers were reported to be using a new forecast - simply that the second wave of infections could be more deadly than the first - to lobby the Prime Minister for another shutdown in England.

"The key issue weighing on European markets seems to be the increasing potential of harsher and more widespread steps towards lockdown as COVID cases continue to remain uncomfortably high or rising," says Tim Riddell, a London-based strategist at Westpac. "The growing level of protests and civil unrest highlight how tensions are building between personal and national economic well being and national health."

Above: NZD/USD, at hourly intervals, tumbles in European hours. NZ 10-year bond yiled ( blue line) tumbles overnight.

Britain’s second wave has been far larger than its first so the suggestion that it could be more deadly might seem like a statement of the obvious if not for the reality that deaths have so-far been much lower than in the initial outbreak. 

The ‘lockdown’ threat sank stock markets and risk currencies alike on Wednesday, although the Kiwi’s downside might be limited up ahead given strong international demand for the government’s bonds, a seemingly superior coronavirus containment and relatively healthier public financial position.

Above: New Zealand government graph showing numbers of coronavirus infections detected and disclosed each day.

New Zealand issued NZ$4 bn of new government debt, effectively borrowing that amount until 15 May 2028 on Wednesday although investors threw more than NZ$18 bn at the NZ Treasury, implying a bid-to-cover ratio in excess of four times and indicating solid domestic and international demand. 

“The strength of demand for NZGBs may seem puzzling given nominal yields are below those in Australia and the US. We can offer several explanations,” says Imre Speizer, Westpac’s head of NZ strategy. “Firstly. NZGB real yields are not at a disadvantage to those of other countries, being equal to those for ACGBs and above those for USTs. Second, RBNZ LSAPs have been more assertive than the bond-buying programmes of most major central banks. Third, the RBNZ has signalled it is willing to adopt a negative policy rate, in contrast to the Fed or RBA. These three dynamics have been in place since Covid took hold, perhaps explaining the stellar performance of all five NZGB syndications.”

Above: Westpac graph showing New Zealand, U.S. and Australian yield curves.

New Zealand government bond yields, which move in the opposite direction to bond prices, have been crushed this year by the Reserve Bank of New Zealand (RBNZ) response to the coronavirus pandemic that’s seen the cash rate fall to 0.25% and the bank threatening to buy up NZ$100 bn of government bonds. 

That’s nearly half of the government’s pre-pandemic stock of outstanding liabilities and so gives the bank a sizable footprint in the market, but most notably the RBNZ is threatening an April 2021 shift to a negative rate policy.

To the extent that this is enough to further drive up the price of NZ government bonds, it could offer support to the Kiwi, although a better track record at limiting the spread of coronavirus is also supportive of the Kiwi. 

“The threat of negative rates isn’t going to go away but it seems the threat of global risk aversion is morphing into fears of what the as yet uncontrolled pandemic means for restrictions and containment, and in turn global growth. In that sort of environment, we’d expect the NZD to do better than other currencies as it did in May, and the path of least resistance still seems to be higher,” says David Croy, a strategist at ANZ. “NZD/GBP price action is very muted and still well within historic ranges. Brexit fears ebb and flow as do rate cut expectations in both markets.”

Above: Pound-to-New Zealand Dollar rate shown at daily intervals alongside NZD/USD (blue line, left axis).

European coronavirus concerns could lift the U.S. Dollar and weigh on the Kiwi for as long as they last, but the outlook for the U.S. currency is also hinged substantially on the outcome of next Wednesday's presidential election, which markets see producing a Democratic Party-led administration under opposition candidate Joe Biden.

Biden’s spending plans are expected to produce an even higher budget deficit than would potentially be the case under President Donald Trump, leading to further Federal Reserve U.S. Dollar creation, while his tax and regulatory programmes are likely to weigh on the U.S. economic recovery.

Above: U.S. Dollar Index (black line, right axis) and U.S. election polling average of Joe Biden (green line, left axis).

Markets have recently come close to pricing out any prospect of a Trump victory so would face a sharp adjustment that weighs on the Aussie in the event that a second Trump administration is the result of the ballot. 

“Price action in FX markets remains within recent ranges in key FX pairs, amid limited activity ahead of next week’s US elections. The lack of movement, especially in G10 space, reflects the mostly unchanged nature of the prevalent narrative around the elections’ results, as polls and political markets still show a “blue sweep” outcome as most likely,” says Shahab Jalinoos, head of FX strategy at Credit Suisse. “With now less than one week to go, it goes without saying that the “time decay” we highlighted last week on the possibility of an upset in expectations ahead of Election Day will rise sharply.”