A Stretched New Zealand Dollar is About to Roll Over says BNZ's Jason Wong

A multitude of indicators are showing the New Zealand Dollar is probably peaking according. 

Conditions, both technical and fundamental, are suggesting that the New Zealand Dollar is topping and is therefore likely to roll-over in the near-term according to BNZ Bank.

The rate-of-change of the exchange rate, for example, has reached a level where it is highly likely to reverse and start going down.

"When percent gains over the prior 12 weeks approaches 9% – as they did in late-July – further gains are harder to come by," says Jason Wong, chief currency strategist with BNZ in Aukland.

CFTC data which measures the sentiment of the speculative market shows the number of funds and professional traders who have bought futures contracts in the New Zealand Dollar has reached a record high.

This suggests a diminished probability the pair will rise further, as the market is now stretched in one direction..

The data table below shows what has happened to the NZD after positioning in the NZD has been stretched to the long side on the last four peaks in 2014, 2013, 2012 and 2011.

On all four occasions the pair weakened by on average 2.7% in the four weeks following the release, 6.5% in the 12 weeks and 5.3% in the 24 weeks after.

Wong argues that the stretched positioning reflects an influx of "hot money" into NZD due to a "distaste for the USD" much like the previous peaks.

Positioning data for the Dollar conversely has reached a 4 and a half year trough and is therefore overstretched to the downside, and as such, due a recovery.

The Dollar index is also looking oversold too, notes Wong:

"Our USD TWI model shows that the USD has fallen by much more than is explainable by interest rate differentials and global risk appetite, with the current 7% gap representing an extreme two-standard deviation event."

This reinforces the notion that NZD/USD - anyway - has probably peaked.

An explanation for the USD "value gap" incidently is that the market has been sidetracked by US political issues, "as Trump’s policy agenda goes off-piste and investigations of Russian involvement in the election remain in the background. Another hurdle that lies ahead is the US debt ceiling," says Wong.

A fundamental analysis of NZD suggests growing political risks of its own as the country gears up for elections which are likely to return a 'hung parliment' - which although not unusual in New Zealand - still appears to raise concerns about political uncertainty.

"Increased uncertainty about the make-up of the next government and the stability of that government throws some caution into the wind for those holding long NZD positions," adds the strategist.

A positive trade balance and terms of trade - the agregate value of exports minus imports - has helped the Kiwi in 2017, however, this is is unlikely to continue.

Higher risk appetite globally has also helped the currency, however, the BNZ risk appetite index is looking toppy at 80% a level at which more gains is unlikly.

Finally, from a monetary policy perspective the Kiwi is also vulnerable as the Reserve Bank of New Zealand looks increasingly like it will stubbornly stick to a no-change, neutral stance for a long time to come - a "lower for longer" policy - in the words of the Bank's monetary policy committtee.

This contrast quite sharply from the much more 'constructive' monetary policy being embraced by the Fed, who are planning to raise interest rates several times more over the next two years, the European Central Bank (ECB) who are planning to unwind their stimulus policies, the Bank of England and Reserve Bank of Australia, who have made overtures to hike rates, and the Bank of Canada who already started with a 0.25% hike in July after years of no-change.

"In conclusion, we’re struggling to see much upward force for the NZD from here and plenty of downward forces," ends Wong.