Sell New Zealand Dollar v Pound and Euro say Strategists Expecting RBNZ to Sit on the Sidelines
June's central banking conference in Sintra, Portugal showed a growing trend amongst central bankers to acknowledge economic growth and hint the time was right to consider ‘turning off the taps’ and reduce monetary stimulus.
The general rule of thumb that reducing monetary stimulus by raising interest rates and ending quantitative easing is positive for the central bank's respective currency.
Governor from the Bank of England, European Central Bank and Bank of Canada all shifted their stances and their currencies profited as a result.
But they weren’t the only ones, “in Scandinavia, the Norges Bank removed its rate cut bias recently, and the Riksbank may follow next week,” says Nomura’s Yujiro Goto in a note highlighting the phenomenon.
As you would expect, moves amongst those currencies that were subject to central bank talk were ultimately negated.
Currencies at risk of weakening going forward are those whose central banks are keen to stand on the sidelines.
Several central banks now appear conspicuous for their absence from the more upbeat hawkish ‘party’, and these include the Reserve Bank of New Zealand (RBNZ) and the Reserve Bank of Australia (RBA).
If anything it will be in the interests of RBA and RBNZ policy-setters to avoid the fray.
This will ensure other central banks will do the heavy-lifting when it comes to devaluing their currencies which many see as being overvalued, particularly the NZD.
Currencies tend to rise when their central bank is on the cusp of, and in the early stages of, a cycle of interest rate rises.
Bet Against the NZ Dollar
Despite showing strong economic credentials – especially in New Zealand – neither the RBA or RBNZ appear to be joining the chorus of calls for an end to stimulus and higher interest rates.
Their reluctance means that whilst the Euro, Pound and Canadian Dollar start rising, the Aussie and New Zealand Dollar’s may lose ground, relatively speaking.
Indeed, Nomura have based a ‘tactical call’ to go long EUR/NZD on the growing distance between the central bank ‘pack’ and the RBNZ.
“We expect European currency to continue outperforming over coming months. This, when combined with our cautious NZD stance, prompts us to recommend a tactical long EUR/NZD position. We would look to buy EUR/NZD at current spot (1.5570) and target a move to 1.6190 (stop at 1.5250),” says Goto.
Morgan Stanley are meanwhile expecting the NZ Dollar to suffer against Pound Sterling.
In a weekly strategy note to clients Morgan Stanley's Hans Redeker says, “additional attention should be drawn to GBP/NZD, where a good rebound seems imminent. Both currencies react very differently to rising nominal funding costs."
Rising nominal funding costs is another way of tapping into the theme of rising interest rates.
“NZD tends to fall more due to its substantial debt-funded foreign liability position, while GBP is more resilient to rising bond yields due to its income balance moving away from its current deficit caused by weak coupon incomes,” says Redeker.
A further rationale for seeing the Euro appreciate versus the New Zealand Dollar is the risk that a rise in interest rates will start to impact negatively on stock markets and create a risk-off environment.
This would be especially negative for NZD.
“We believe the more hawkish stance of some of the global central banks’ could also pose short-term downside risks to higher beta commodity currencies via possible “risk-off” market reactions, particularly if inflation data start to accelerate and validate the hawkish rhetoric," says Goto.
Within the commodity-bloc, Nomura think the NZD is the most vulnerable to an adjustment.
As the Japanese investment bank highlighted recently, the low level of market volatility has been one of the key supports to NZD, and a lot of positivity now looks to already be price in.
"Also, with our cross-market risk indicator having moved away from “risk seeking”, this part of the positive NZD narrative looks to be fading,” says Goto.
New Zealand Economic Slowdown
Elsewhere, BNZ believe the RBNZ will be reluctant to pursue higher interest rates as the New Zealand economy could see growth rates fade.
BNZ economist Stephen Toplis notes that first quarter GDP woefully undershot expectations of 0.9% by coming out at only 0.5%, and this might be contributing to the RBNZ’s hesitancy.
He further highlights the fall in inflation after the price of oil plummeted.
“Of greatest significance is the fact that inflation indicators have taken a turn to the low-side. Oil and, in turn, petrol prices have plummeted,” says Toplis.
They have fallen so much that BNZ have lowered their Q2 CPI forecast to 0.1% and slashed their Q3 estimate to 0.2%.
The outlook is now for a significant slowdown in inflation to only 1.2% in the year to March 2018.
Given that the RBNZ’s forecasts are even more conservative than BNZ’s, Toplis expects their revisions to be even lower when they publish them in August.
This is even more the case given the RBNZ have not yet incorporated the oil price plummet.
Finally, the RBNZ’s current inflation forecasts are based on a New Zealand Dollar trade weighted exchange rate of 75.0, when the real TWI is well above that at 78.0.
The relatively strong New Zealand Dollar will be a further depressor of inflation.
“The RBNZ had assumed the TWI would average 75.0 through the September quarter. If it stays where it is (78.6) then this, by itself, could take 0.5% off the Bank’s year-ahead CPI forecasts and, in turn, demand an even lower interest rate profile than the RBNZ currently assumes. Indeed, at face value, it would demand rate cuts,” says Toplis
A steady rise in commercial banking interest rates – with mortgage rates now 50 basis points higher than the RBNZ base lending rate - combined with fears about the overheating housing market, are further reasons for keeping rates low.
For all these reasons, the RBNZ is justified in keeping its dovish stance.
Risks RBNZ May Join the Central Bank 'Pack'
Despite the fall in growth and inflation and the rise in value of the New Zealand dollar providing compelling reasons for the RBNZ to keep rates low, and thus setting up a divergence with the rest of the G10 central banking chorum, there are also risks of RBNZ giving up its idiosyncratic stance and joining the hawkish ‘pack’.
This would jeopardise the "weaker NZD" assumption.
There are some points to consider, as to why the RBNZ might want to actually raise rates:
1) food prices remain stubbornly high.
2) Inflation expectations, though subdued, are still expected to remain at the midpoint of RBNZ’s target range.
3) Fiscal policy could be quite stimulatory as austerity unwinds; commodity prices have risen and terms of trade are at record highs.
4) The labour market is in excellent shape and the economy is reaching its full operating capacity.
In addition, there is a possibility the RBNZ could be persuaded by peer-group pressure of joining the more hawkish main group of central banks, since there is evidence governor Wheeler has been influenced in such a way in the past.
Nevertheless, all things equal, the Kiwi does not look like it has the fundamental underpinning to be the best performing currency in the second half of 2017.
