New Zealand Dollar Faces Cooler Prospects: Westpac Forecast

New Zealand dollar forecasts for the near-term warn of a potential decline but we look at why the currency has been so strong of late and what this means for the remainder of 2016. 

Westpac’s custom foreign exchange forecasting suite suggests that the outlook is cooling on the New Zealand dollar following a strong performance this February.

The New Zealand dollar has been an outperformer of late, dodging negative market conditions, to register strong gains on a combination of strong domestic labour market data and an across-the-board rout of the US dollar.

Westpac's G10 model, which uses a combination of 9 forecasting variables, has cooled on the NZ Dollar and recommends selling the currency in the week ahead.

This is the first time the model has had a decent NZD short in many months.

“Despite some more constructive risk appetite signals the narrowing in 10yr NZD v G3 bond spreads is the more important signal for the model,” says Richard Franulovich at Westpac.

Elsewhere the model sees little to do in AUD, a stronger growth signal but still poor long term valuation leaving the model neutral.

Westpac’s model remains long on EUR another week too, however it is against the US dollar where the potential for gains exist.

“A bullish US data surprise index signal remains the feature theme for the G10 FX model portfolio. The signal remains live for another two weeks, betting on yet further improvement in the complexion of the US data,” says Franulovich.

A slightly firmer total yield signal for the USD adds to the model's strong predilection for USDs.

For the week ahead the model has an over the top 65% long USD exposure, almost double last week's long USD position.

Medium-Term Risks Skewed to the Downside

Market sentiment at the start of the week is positive thanks to good news out of China.

As always, this tends to aid the likes of the New Zealand and Australian dollars.

The PBoC’s decision to set the USD/CNY fixing to 6.5118, down 0.30%, helped risk sentiment to improve substantially. As a result Asian regional equity markets started the week trading on a firmer footing.

“Commodity currencies took advantage of this environment as the Aussie, the Kiwi, the loonie and the NOK were all printing solid against the US dollar in spite of a consolidation of crude oil prices,” says Arnaud Masset, market analyst at Swissquote Bank.

“We expect the NZD to remain range-bound in the near-term, as market sentiment settles. NZD/USD has displayed resilience to global risk, but the flipside has been a failure to break higher on USD weakness, and to subsequently decline with Friday’s improved USD sentiment,” says a foreign exchange briefing from the FX team at ANZ Bank.

ANZ believe that medium-term risks for the NZD remain skewed lower, with commodity price and global growth unease unlikely to dissipate.

Why the New Zealand Dollar has been Stronger

The resilience of the NZ dollar of late - in the face of global market turmoil to boot - has impressed many in the foreign exchange community.

“Typically it would fall on global credit and equity unease. For sure, USD weakness is adding buoyancy to
the NZD. But the resilient NZD is symptomatic of a nation that, while not without its challenges, is wearing one of the cleanest of the dirty shirts,” say ANZ.

Why is New Zealand in a better position now than it was say in 2011 when we last saw negative market conditions, as we are presently witnessing?

A couple of pointers:

The New Zealand current account deficit is smaller. In 2008, the deficit was 8% of GDP. It is now at 3.3%, and actually below its historical average.

The national balance sheet is stronger. Net external debt, at 56% of GDP, is the lowest in 12 years and down from 85% in 2008.

Roll-over risk has reduced. The country’s international debt liabilities maturing in less than 90 days has fallen from half of the total in 2008, to less than a quarter now. That buys time.

Domestic economic momentum is still strong.

“Now that could change quickly, if the signal provided by the tightening seen in financial conditions is anything to go by. But to date, the economy has reasonable momentum, as shown by the latest activity data. Momentum is important; many forget that the economy was already in recession before the GFC actually hit,” say ANZ.

BUT

There is always a but, and this is where the NZ dollar story could potentially unravel.

“New Zealand’s balance sheet metrics are better than pre- 2008, but still not strong, and they have shown signs of deterioration recently: household saving is slipping, and leverage is rising,” say ANZ.

Furthermore analysts argue that commodity dependency is still high, and dairy price action is poor amidst high leverage in the sector.

Housing is showing bubble-like characteristics in Auckland. We are linked into China both directly and indirectly (via Australia).

“The balance of power globally is shifting back to the savers; New Zealand is a net borrower. So we can’t simply blow off the potential flow through,” say ANZ.

So while the justification for the recent New Zealand dollar outperformance exists, there remain lingering concerns.

That said, the tone towards the currency is certainly fundamentally more constructive than at the same time last year.

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