New Zealand Dollar Tipped as Buy after RBNZ Seeks to Turn Policy Aircraft Carrier 

Pine timber being exported from Wellington, New Zealand. Photo by James Anderson, World Resources Institute.

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The New Zealand Dollar remained the week's best performing major currency on Thursday and has been tipped as a buy at Westpac after the Reserve Bank of New Zealand (RBNZ) signalled a pending shift in its interest rate guidance, potentially removing what has been a key headwind for the Kiwi of late. 

RBNZ policymakers have warned for months about an imminent shift to a negative interest rate policy, while also threatening to carry out large sales of Kiwi Dollars on the market in order to reign in exchange rates by buying up foreign assets, although November's policy update brought a change of tack.

"Global sentiment has been positive lately, capping the US dollar. But the NZD has also outperformed all the majors. NZ’s economic outperformance during the Covid recovery is one explanation, with another being reduced expectations for OCR cuts," says Imre Speizer, head of NZ strategy at Westpac. "Yesterday’s RBNZ MPS delivered more easing via an FLP scheme."

New Zealand's government was quicker to contain the coronavirus than others and before the pandemic it had one of the lowest debt-to-GDP ratios in the developed world, leaving the RBNZ's policy stance appearing incongruous with that of other central banks as well as the better-than-expected reality on the ground in New Zealand.

Those discrepancies were acknowledged Wednesday when the RBNZ lifted forecasts for the cash rate by around 130 basis points for September 2021, suggesting rates are no longer likely to fall as far below zero as had once been envisaged, which has bolstered an ongoing rally in Kiwi exchange rates. 

 Above: NZD/USD rate shown at hourly intervals alongside S&P 500 index futures (black line, left axis). 

Governor Adrian Orr said Wednesday that international and domestic demand had proven more resilient than assumed, before singling out the domestic job market and strength of recent household spending for acclaim. The bank still expects a "very large and persistent" shock to keep employment and inflation below target levels for years yet, but less so than in its August policy update, indicating that lesser support may now be necessary. 

"Members discussed the outlook for inflation and employment. Staff presented a baseline scenario, conditioned on a number of assumptions, including that there were no further substantial community outbreaks of COVID-19 in New Zealand, and that the international border would be fully open by 2022. In this scenario, the labour market was projected to weaken further in the near term. It was projected to recover over subsequent years, in particular after the border was assumed to be fully reopened," the RBNZ said. "Inflation was projected to fluctuate around the bottom of the Committee’s 1 to 3 percent target range."

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This, progress toward a coronavirus vaccine and a possible January change of leadership at the White House all reduce the headwinds facing the New Zealand Dollar, and could potentially enable it to continue outperforming over the coming months. The U.S. election outcome is a prospective boon for China's economy, which is New Zealand's largest trade partner, while the successful rollout of a coronavirus vaccine would be a gamechanger for the global economy and could also be the key to an earlier reopening of NZ borders. 

As a result expectations for Kiwi Dollar weakness have reduced and RBNZ angst over any future strength is thought to be less likely, while both have played a role in Westpac's advocation that clients of the bank bet on a nearly 5% increase in the trade-weighted New Zealand Dollar during the months ahead. 

"Today we got more positive economic news – another very strong housing market update, which should keep the NZ economic outperformance story alive for a while yet," Speizer says. 

Above: Currency weightings for trade-weighted New Zealand Dollar exchange rate. Source: RBNZ. 

Westpac's idea implies Kiwi gains over the Aussie, U.S. Dollar, Japanese Yen, Pound Sterling and Euro, which collectively account for around 55% of the trade-weighted index. Other exchange rates likely to see increases include NZD/KRW and NZD/CNH, which are worth around 25% of the index. 

"The RBNZ is slowly marking their excessively pessimistic forecasts to market as the story on the ground is bullish while the story in their Monetary Policy Statement remains morose. They are trying to turn the monetary policy aircraft carrier slowly to avoid sending NZD to the moon while still acknowledging all the positive new information," says Brent Donnelly, a spot FX trader at HSBC. "I think this sets up for an eventual admission that negative rates are the last thing the New Zealand economy needs."

Donnelly says the RBNZ is evolving its forecasts to match reality after the housing market boomed amid the pandemic and despite New Zealand's national borders remaining closed for a period that could extend to the end of 2021. 

A resilient job market has also taken investors, traders, analysts and policymakers by surprise, with the jobless rate rising only to 5.3% in the third quarter, its highest since the final quarter of 2016 but one that remains below the 7.3% peak seen during the recovery from the 2008 financial crisis. 

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Parts of New Zealand suffered a second but short-lived lockdown last quarter while the whole country's tourism industry, which is though to be worth around 6% of annual GDP, has remained under lock and key throughout but despite this the pace of job losses and resulting increase in unemployment has been less.

While RBNZ policymakers may now not have to go quite as far as they've recently suggested they would, this could also see New Zealand retaining its best-in-class national balance sheet as well as offering investors bond yields that remain higher than those in many other major economies. 

This, in an environment where other countries' national balance sheets were already bloated and are still deteriorating at a rate of knots while their central banks squash the yields earned by investors in the bond markets, is potentially a recipe for further ongoing New Zealand Dollar strength. 

"The next employment data are particularly important," Donnelly says. "I still like AUDNZD lower but I modified my parameters a bit given the large drop. I lowered the stop loss to entry point and will try to buy half back at 1.0557."

Above: NZD/USD rate shown at daily intervals alongside AUD/NZD rate (black line, left axis).