Investment Banks Bearish on New Zealand Dollar Outlook for Remainder of 2016

Two leading institutional researchers have told clients why they are not convinced strength in the NZ dollar will be sustainable in 2016.

Compared to its developed peers, economic growth in New Zealand has remained resilient at above 2% on an annual basis, supported by strong domestic demand and high migration flows.

The strong factors have understandably favoured strength in the kiwi dollar, notably against pound sterling.

The GBP to NZD exchange rate has been in a downtrend since September 2015 when highs above 2.4600 were rejected.

Against the US dollar the Kiwi has been in a holding pattern for months now with the NZD/USD oscillating between 0.68 and 0.64.

But, don’t be fooled by the recent strength seen in the New Zealand dollar argue analyst at two leading institutions, particularly against the likes of the US dollar.

“While recent resilience in NZD has seen our near term forecasts revised a touch higher, we continue to retain a bearish profile for NZD over the course of this year,” says Sally M Auld, analyst with JP Morgan.

Factors Advocating for a Weaker NZD

JP Morgan are bearish NZD citing structural and cyclical forces being in alignment to force further depreciation.

Auld and her team say they still see NZD as subject to the following “material” structural headwinds:

1) housing exuberance,

2) rising credit growth,

3) a negative and falling saving rate 

3) a widening Current Account deficit (the country's international trade bank account is overdrawn)

New Zealand’s seasonally adjusted Current Account balance was a deficit of $1,948 million in the December 2015 quarter ($221 million larger than the September 2015 quarter deficit).

Dairy prices are imparting a persistent drag on the terms of trade, widening the Current Account deficit, “meaning the economy is depleting savings just as the income shock begins to manifest itself,” says Auld.

Importantly, Auld argues that while more near-term dairy market stability may make NZD look cheap on the surface, it is does not bode for a genuine recovery.

“Recall that dairy cooperative Fonterra engineered a modest price bounce
in 4Q15 by curtailing their pledged auction supply, but prices are still well below break-evens for most farmers,” says Auld.

The RBNZ’s Financial Stability Report flagged the risk of rising NPLs on farm loans and significant declines in farm land values, given forecast cash-flow shortfalls for the sector.

Morgan Stanley: It’s All About Inflation and the RBNZ

Morgan Stanley have meanwhile added to the soft-NZD narrative and confirmed to clients that they expect more weakness in NZD as disinflationary pressure triggers more easing by the RBNZ in the coming months.

Headline inflation has consistently missed the 2%Y midpoint of target range (1-3%Y) since 2011, putting increasing pressure on the central bank to fulfil its obligation to maintain stable prices.

“As most of the disinflationary pressure is coming from offshore, the key transmission mechanism for the central bank to support inflation is via currency weakness,” say Morgan Stanley in a note containing their latest set of foreign exchange forecasts.

The recent decision by the RBNZ to cut interest rates, while not universally welcomed, is held to have been the right decision for a central bank looking to boost inflation and lower the exchange rate.

“For the currency, the most important implication of the recent RBNZ decision was that the RBNZ has provided a revised real 90-rate profile which is consistent with their desire for a lower currency, especially over the longer term. All else equal, this should be a reasonably powerful anchor for the currency near term,” says JP Morgan’s Auld.

Expect a repeat of the move should the Kiwi dollar start appreciating once more.

“It is likely that the RBNZ will act on its current dovish bias to cut the official cash rate (OCR), driving further NZD weakness,” say Morgan Stanley.

Analysts are forecasting the NZD/USD exchange rate at 0.64 by mid 2016 0.62 by the third quarter and 0.61 by the end of the year.

JP Morgan’s June 2016 target is 0.65, with the December 2016 target at 0.61.

“The RBNZ appear to have finally accepted the need for a lower real rate structure, which should help the currency to move lower,” says Auld. 

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