New Zealand Dollar "Strength to be Respected" but Threats to Dominance Growing

For the New Zealand Dollar, it would appear that the balance of risks against its G10 partners is to the downside.

The NZD has been one of the better-performing members amongst the group-of-ten of the world’s largest currencies over recent years but we are seeing notable shifts in the global financial system that could question this strength.

“The NZD’s strength is to be respected, but it’s being challenged on a number of levels,” say ANZ Research in a weekly currency strategy briefing.  “Yield differentials are closing, there are more signs the liquidity cycle is set to turn, German 10 year bunds and JGB’s are near pivot points, and NZD positioning is elevated.”

So there are threats to the New Zealand Dollar’s dominance with the rise in yields in other markets apparently being the most important.

Recall that New Zealand boasts the highest interest rates in the G10, something that attracts strong inflows of foreign currency as investors look for a good return on their capital.

This flow - which supports the NZD - is also dependent on interest rates being very low elsewhere. In effect it is profitable to borrow cheap Euros, Pounds and Yen, transfer it to New Zealand and watch it grow.

However, mid-2017 has seen a shift in attitude by the likes of the Bank of England and European Central Bank which are warning that a future of higher interest rates lie ahead.

This puts the flow of money to New Zealand at risk and suggests the New Zealand Dollar might not be able to rely on foreign exchange inflows to stay propped up.

Both Mario Draghi of the ECB and Mark Carney of the BoE told an audience at the Forum for Central Banking in Sintra, Portugal in late June that they believe the case for ‘tighter’ monetary policy was becoming more valid.

Markets bought the Euro and Pound as a result.

“New Zealand’s ‘clear #1’ position across a number of key ‘relativities’ (growth, yield, unemployment and debt) is being challenged,” say ANZ Research. “Interest rate differentials remain an absolute advantage, but the comparative advantage is slipping.”

Indeed, against the US Dollar there is a mere 0.5% advantage separating the NZ and US policy rate.

This spread was as high as 3.25 %pts just two years ago, and is set to be at or near zero by year-end.

“Collectively, these considerations leave us wary chasing NZD strength around current levels,” say ANZ.

However, New Zealand’s strong economy is expected to mitigate, or slow, any notable shift in fortune for the currency.

And against Pound Sterling the outlook for the NZ Dollar is positive owing the UK’s slowing economic momentum and concerns over Brexit.

Official Forecasts for GBP/NZD show Sterling Should Move Higher

ANZ are officially forecasting the Pound to New Zealand Dollar exchange rate to trade at 1.8181 by the end of 2017, up from the 1.7746 we see at present.

This forecast is at odds with their strategic bias that suggests losses lie ahead. It is explained via their valuation models which show Sterling is looking cheap when contrasted to fundamentals.

The economy, and interest rates suggest the Pound should be much stronger than it is.

But that lingering political and Brexit uncertainty means the Pound must trade at a premium.