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New Zealand Dollar Biased Lower as El Nino Likely to Prompt RBNZ Cuts

The New Zealand Dollar's Outlook is Clouded by a Lack of Clouds in the Sky.

el Nino seen as more sever than 1997

New Zealand's currency has advanced in the face of soft dairy prices, supressed global commodity dynamics and a Reserve Bank of New Zealand that consistently reminds us that it does not like an expensive currency.

With this in mind, those hoping for a softer NZD will be feeling out of luck.

The pound to New Zealand dollar exchange rate is seen trading at 2.2634 on the inter-bank markets, well below the best level seen back on the 18th of November when those blessed with good timing bought NZD with GBP at just above 2.35.

Ahead of that the longer-term uptrend in GBPNZD had deliver levels just above 2.46.

While the conversion is seen above 2.26 on the live markets at the present time we note banks are conducting their client’s payments at around just below 2.20. FX specialists are however quoting transfers above 2.23.

Will the New Zealand Dollar Fall?

We have a big unknown for the NZD’s future valuations which comes in the form of rainfall.

The world is in its latest El Nino weather event, according to forecasters this could well be the strongest such event in more than 50 years. The graphic at the start of the article shows just how warm Pacific ocean temperatures are compared to the 1997 event.

For New Zealand El Nino typically delivers below-average rainfall and drought. In New Zealand, severe droughts are typically associated with recession.

The impact of drought on the New Zealand dollar could therefore be notable owing to the large chunk agriculture contributes to the economic pie.

At the moment the exact impact of a stressed agricultural sector is hard to quantify in currency terms owing to all the shifting parts, but on balance, the risks are weighed to the downside.

This farming season continues to be a challenging one for some regions.

“While holiday makers will be looking for good weather over the Xmas/New Year period, farmers on the east coast from Dunedin through to the Wairarapa will be looking for rain. While conditions are quite variable, many areas within these regions continue to suffer from fairly significant soil moisture deficits,” says a note on the matter from ANZ Research.

Now that the effects of El Nino are forecast to continue into the Southern Hemisphere Autumn; a tough summer therefore lies ahead.

It is by no means a closed book for farmers though with many deemed to be well prepared and already taking action.

“That said, dairy farmers in these regions don’t need any more challenges and many other livestock farmers don’t have the same access to irrigation as dairying. Those who are facing their second significantly dry summer, don’t have irrigation, or water takes are already being restricted (such as parts of North Canterbury) face more difficult and potentially expensive choices,” say ANZ.

RBNZ Looks to Provide a Cushion

Researchers say that while there are a lot of moving parts as always, but these conditions and their impacts on agricultural production and soft commodities markets will need to be closely monitored through the next few months.

As already mentioned though, the risks are tilted to the downside though.

For the New Zealand dollar’s outlook the mechanism by which a stressed agricultural sector will impact valuation is via the RBNZ.

The RBNZ will be looking at the likely scenarios that drought delivers over coming months and could pre-empt any downturn with interest rate cuts.

The RBNZ will want to avoid taking a laidback approach to rates, particularly considering how high New Zealand interest rates are when compared to the rest of the world. As rates are cut so the advantage of buying NZD-denominated assets declines, ensuring demand for the currency declines in tandem.

Rate cuts are therefore held to be NZD-negative.

There are other reasons why the RBNZ could opt to cut rates over coming months though say ING in a note to clients:

  • softer inflation dynamics and weaker dairy prices since Oct means that the two key inputs in the RBNZ’s reaction function have deteriorated;
  • the NZD nominal trade-weighted index is around 6% higher than the time of the Sep MPS projections (policymakers are highly averse to any near-term currency strength);
  • the central bank has one contingency 25bp rate cut pencilled into their forward rate path (failing to exercise this may signal a shift in the policy bias from dovish to neutral).

The RBNZ are expected to ease rates again in December with consensus expecting a cut of around 18bps.

Be aware that the RBNZ will however be wary of high house prices and this could well persuade the RBNZ to keep rates level, thereby avoiding a fresh rush of borrowed money into the hot housing sector.

However, such a move would be a big positive for the NZD and could well evoke a response similar to that seen when the ECB disappointed markets with a timid policy response on December 3.

Forecasting the direction of house prices is however a lot easier than quantifying the impact of a drought whose severity is impossible to judge at this stage. As such this remains the big unknown for the NZD over coming months and the RBNZ is likely to err to an easing bias.

 

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