New Zealand Dollar: Investment Banks Chase Weakness

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Chasing New Zealand Dollar weakness remains a favoured strategy with analysts at some of the major investment banks amidst fears the New Zealand economy is set to struggle.

JP Morgan says it recommended selling New Zealand Dollars a month ago following news that New Zealand's economy contracted in the final quarter of 2022.

The view still holds today: "NZD remains a strategic short for us - momentum has picked up following the RBNZ 50bp surprise earlier in the month," says Patrick R Locke, a strategist at JP Morgan.

JP Morgan was also concerned by a March 14 report from S&P that warned New Zealand's current account deficit was much wider than it had anticipated and it's credit rating could come under pressure as a result.

A sharper-than-expected fall in inflation in March was meanwhile the latest catalyst for NZ Dollar weakness as it signalled the Reserve Bank of New Zealand (RBNZ) could soon afford to pause its rate hiking cycle.

"NZD has still understandably underperformed given current growth momentum, prospects for further mortgage tightening over time, and more tactically this week the CPI undershoot," says Locke.

The RBNZ commands the highest base rate in the G10, which would typically align the New Zealand Dollar with outperformance.

But these high rates are contributing to an economic slowdown with New Zealand's once red-hot property market starting to struggle.

BNP Paribas - the global investment bank and lender - finds New Zealand's property sector is particularly vulnerable to the recent rise in interest rates.

"Sweden and New Zealand look most vulnerable to a property-led economic downturn, according to our analysis," says Parisha Saimbi, FX Strategist at BNP Paribas, and this will have implications for the NZ Dollar's outlook.

The RBNZ has delivered eleven interest rate hikes since October 2021, taking the Official Cash Rate to 5.25%.

This puts pressure on local lenders to raise rates on their own loans and mortgages which puts the squeeze on businesses and households with the intention of bringing inflation under control.

But risks of a sharp housing market slowdown and economic contraction mean the RNBZ might have to readjust interest rates lower, something that could weigh on the NZD.

"We see risks that the RBNZ may not be able to deliver as many hikes as it projects, or may need to cut rates earlier and/or more aggressively," says Saimbi.

"We project RBNZ easing later this year," says JP Morgan's Locke.

In particular, JP Morgan looks for the New Zealand Dollar to underperform the Euro as the European Central Bank has more to do in terms of raising interest rates.

The Kiwi is the second-biggest loser of 2023 as investors react to deteriorating fundamentals in New Zealand.

But a word of caution from another investment bank that the recent decline in the Kiwi might be overextended.

The New Zealand Dollar "looks oversold" says Bank of America, "this suggests caution on near-term NZD shorts."

The findings are based on one of the bank's bespoke models that attempts to assess whether a move in a currency has overshot its fundamentals.

BofA says the Pound has become overvalued based on modelling, whereas the ongoing decline in the Kiwi leaves it looking oversold.

Therefore, now might not be the time to bet on fresh downside.