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New Zealand Dollar Outlook

Last updated 1/6/2012 4:21 AM ET (GMT -5) 0 Comments - Add your comment

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Kathy Lien

Director of Currency Research, GFT

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Like many of the other major currencies, the New Zealand dollar performed very differently in the first half of the year. Between January and August, NZD appreciated as much as 13% against the greenback, but between August and December, a steep sell-off stripped away all of the currency’s gains, leaving it virtually unchanged. Compared to the beginning of the year, the value of the New Zealand dollar has not changed much – the only currency that saw any material movement in 2011 against the NZD was the Japanese yen, which attracted a significant amount of safe haven flow. In the beginning of 2011, Mother Nature was particularly unkind to New Zealand, shaking the ground in Christchurch and causing significant damage – twice within a five-month time frame. In response, the Reserve Bank of New Zealand cut interest rates by 50bp in March and the country spent most of the year recovering from the earthquake.

Initial Signs of Weakness in the Economy Could Worsen

New Zealand is an extremely small country with a very small economy. Area-wise, it is no larger than the state of Colorado with a population smaller than New York City, which explains why the country’s economy and their currency are extremely sensitive to the ebbs and tides of the global economy. Australia is New Zealand’s most important trade partner followed by China. In the beginning of the year, New Zealand’s economy was hit hard by the earthquake in Christchurch. The Reserve Bank responded quickly by cutting interest rates, which provided significant support to the local economy. For the rest of the year, economic growth was fueled by rebuilding efforts and by October, the RBNZ was talking about reversing their prior hike. Unfortunately, a lot has happened in the world since then and despite the geographic remoteness of Europe, New Zealand was not immune to the troubles on the continent with consumer confidence plunging in November, terms of trade dropping in the third quarter, and business PMI and performance of services index deteriorating in October. The weakness is not widespread quite yet, as there have been upside surprises in trade and retail sales. But if growth slows materially in China and Australia, it will affect demand for New Zealand exports and in turn, New Zealand economic data. The OECD expects the economy to grow by 2.5% in 2012 followed by 3% the following year which compares to the Treasury’s forecast (from October) of 3.1 and 3.5% growth. This difference of one percentage point is huge and contingent upon the risk that further increases in overseas debt could hamper the recovery along with any backsliding on the government’s surplus.

RBNZ – To Remain in Wait and See Mode

The risk of slower growth for New Zealand’s trade partners means that the Reserve Bank of New Zealand could maintain its easy monetary policy longer. With inflationary pressures easing in the third quarter and expected to slow further in the coming months, there is little urgency for the Reserve Bank to unwind their rate cut. Going into 2012, we expect the RBNZ to be in wait-and-see mode, watching how the Eurozone economy performs carefully. Having cut interest rates early on and providing enough support for the economy, the RBNZ will probably be one of the first central banks to raise interest rates once the European situation is normalized. The chance of the RBNZ lowering rates in 2012 is lower than any of the other central banks and with rates higher than most other major countries, the New Zealand dollar could outperform in the coming year. With that in mind, however, it is also important to remember that the New Zealand dollar is still considered a risk currency. For this reason, even if New Zealand’s economy outperforms, their currency could still be hit by risk aversion.

Smooth Reelection Brings Political Stability

What will help New Zealand in the coming year is its unique political stability. John Key swept to victory in 2011, winning his reelection bid by a landslide, a remarkable achievement for any Western government in this current economic environment. With a debt-to-GDP ratio of only 38% (which is well below the 93 to 107% range for the U.S., UK, and Europe), New Zealand’s fiscal finances are in an enviable position. Its deficit for the coming year is expected to be less than 1% of GDP and Mr. Key has pledged to bring the budget deficit back into surplus by 2015. But with lenders expected to be more cautious, small countries like New Zealand may find it difficult to access credit if commodity prices decline. Because New Zealand banks and businesses rely heavily on foreign funding, if uncertainty in other parts of the world sends borrowing costs higher, the economy could suffer.

Be Wary of Deleveraging Risk

Like the Australian dollar, balance sheets matter little when investors are nervous and flock to the safety of low-yielding currencies. The greatest risk for the New Zealand dollar in the coming year is not the performance of New Zealand’s economy, but rather the continued uncertainty in Europe. In 2011, we saw how much damage risk aversion can have on the New Zealand dollar. If the problems in Europe intensify and rating agencies start to cut ratings left and right, NZD could fall sharply even if the government is doing a fantastic job of managing its balance sheet, and its local economy. When the dust settles, New Zealand could come out a winner, but before that happens, the currency’s fate will be in the hands of Europeans.

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.