NZD Corporate FX Update
- The strong recovery in the NZD against all the majors over the past month corrects the pricing anomaly seen earlier in the year. A period of consolidation is now due.
- Our projection for the NZD to head down to USD 0.67 over the next 3-6 months is contingent on a rebound in US inflation that keeps the Fed on course to normalise policy.
What a difference a month makes. After earlier puzzling over NZD weakness in the face of strong fundamentals such as high risk appetite and rising NZ commodity prices, the NZD has staged a strong recovery. It remains below our short term fair value model estimate of USD 0.75 but we aren’t banking on the NZD making further gains. The NZD is close to key technical resistance levels and we think some consolidation is now due.
NZD/AUD Finally Recovers; What Next?
- NZD/AUD recovered strongly by 4% in May, correcting the pricing anomaly we saw develop through March-April. Signs of a pothole in Australian growth and much stronger relative NZ/Australia commodity pricing goes some way towards driving the cross back towards a fairer value.
- Our medium-term outlook of an eventual move towards parity remains, based on the macro outlook continuing to favour NZ over Australia.
- After the strong recovery, the near-term outlook is now cloudier, but our central forecast is that a period of consolidation around the mid-90s should play out.
Our view on the NZD/AUD cross rate hasn’t changed, but given the big swing in that exchange rate this year, an update on drivers and thoughts seems appropriate. The cross began the year just over AUD 0.96, fell steeply from the end of January to mid-March to around AUD 0.91 and has since trended higher in a jumpy fashion to the current rate of just over AUD 0.95.
Peeling Back the Drivers
- Traditional key drivers like risk appetite and terms of trade have not had their usual influence on the NZD so far this year. The lack of NZD carry seems to have had more influence and the market is, for now, giving due consideration to the RBNZ’s extended low rate guidance.
- US CPI and Trump’s questionable actions have recently clouded the outlook for Fed policy and the USD. The USD looks a little oversold at this juncture if one believes that ultimately political risks will fade and inflation will recover.
- Overall, while some fresh news has injected more uncertainty about the outlook, we remain comfortable with our year-end target of USD 0.67.
Currency markets are typically buffeted by a range of factors and half the battle is working out what the key driving forces are. Those forces tend to vary over time, come and go in terms of their importance, and new factors to consider pop up from time to time.
NZD Corporate FX Update
- Commodity currencies have been out of favour over recent months and the NZD has been swept down, despite NZ’s softer commodity basket outperforming. Additionally, the RBNZ remains relaxed about the inflation outlook and the Bank is unlikely to rush into firmer policy guidance.
- short-term forecasts and leave our year-end target at USD 0.67 but flag downside risk to that as well.
NZD Looking Short-term Oversold
- Over the year to date the NZD has underperformed, against economic fundamentals which have remained supportive. These include high risk appetite and strong NZ terms of trade. Net speculative short positioning is the greatest in nearly two years.
- Thus, there is a low hurdle rate for the NZD to recover over coming weeks and months. That said, ultimately see NZD/USD and NZD/EUR ending the year at 0.67 and 0.59 respectively. Economic relativities are expected to encourage NZD/AUD to gravitate to the mid 0.90s.
NZD/EUR: A Couple of Big Unknowns
- NZD/EUR strength relative to our long-run fair value estimate of EUR 0.55 reflects NZ’s relatively strong terms of trade and the ECB’s highly accommodative monetary policy stance. Using a simple short-term model we can explain the current spot rate around EUR 0.66.
- Our projections show the cross holding up at, or above, current spot over the next six months, before facing headwinds and ending the year closer to EUR 0.64. However, our forecasts for EUR (and GBP) are under review pending the outcome of the French Presidential election and the surprise UK snap election announcement.
- The balance of risk is skewed to the downside over the medium-term, reflecting the likely strength of EUR once the ECB normalises monetary policy. The timing of ECB rate hikes is important, but uncertain. An offsetting factor is on going euro-area political risk, with the focus likely to turn to Italy late this year or early next year after the French Presidential elections are out of the way.
NZD Corporate FX Update
- The NZD continues to consolidate after a significant fall in early March. While rising geopolitical risk is undoubtedly NZD-negative, a soft patch in US economic data sees the market trimming back Fed hike expectations. These two offsetting forces could see a relatively steady NZD over coming months.
- Our (unchanged) forecasts see the NZD hover around the USD 0.70 mark over the next 3-6 months, before headwinds re-emerge, resulting in a year-end target of USD 0.67.
Low Volatility Indicators Belie Global Uncertainty
- Low volatility is prevalent across equities, bond and currency markets. This theme belies the widely followed “global policy uncertainty” indices that suggest heightened uncertainty. There are a number of identifiable risks to the outlook but we’d argue that the outlook is no more uncertain than usual. We think that clear central bank guidance is one factor behind the low vol environment. This removes a large source of uncertainty about the outlook for interest rates.
- Low vol implies high risk appetite. We think that risk appetite is likely to be weaker later in the year and this will be one factor acting as a headwind for the NZD.
- Times of low volatility can provide opportunities for investors to consider buying some cheap(er) protection via options. Hedging structures via options have become more attractive and should be on the radar for exporters and importers.