The New Zealand Dollar started the year strong rallying for nearly 800 points in unison with global equity markets, but the price action stalled at the 0.8200 level, as risk aversion and fears of a global economic slowdown put a lid on any further progress. Record commodity prices and aggressive action by the Fed which calmed fears in the wake of the Bear Stearns crisis propelled the pair to a 25 year high of 0.8213 in February. However, high interest rates and a global financial crisis have started to weigh on the New Zealand economy, putting an end to the central bank’s tightening policy. As we enter into the second quarter, the high yielding currency should continue to be a favorite of traders as long as commodity prices remain near their record highs, and the global economy remains resilient. However, if the slowdown in the US spills over into emerging markets and the demand for commodities begins to wane, the kiwi could be in for rude awakening.
Despite a strong currency and record high interest rates the New Zealand economy was able to grow 1% and narrow its trade deficit to –3.41 billion in the fourth quarter. Exports which account for 30% of the economy saw an increase of 25% on the back of record high dairy prices. Companies trying to keep up with demand from emerging markets pushed the country’s unemployment rate to an all time low of 3.4%. A strong labor market in turn spurred an increase in consumer spending, resulting in retail sales growing another 0.3% in January.
However, the headwinds from the tightening credit markets and the U.S. downturn are expected to filter through to the New Zealand economy. Fears that the country may be entering a period of slowing growth and continued inflation sent business confidence to a 33 year low. Consumer’s confidence has taken a similar hit falling to 96.5 from 110.0 the quarter prior, as a record benchmark rate have sent mortgage rates as high as 10%. The recent rate hikes by the RBNZ were done in an effort to dampen the housing sector, which had been the primary driver of inflation. The central bank raised rates to a record 8.25% in an attempt to cool the economy and reign in price pressures. However, the recent financial crisis may bring about a sharper slowdown than the central bank anticipated, although for now the focus remains clearly on inflation. RBNZ Governor Bollard recently stated that “world inflation is rising” and “central banks will continue looking at that issue unless they see real deterioration such as in the U.S.” Therefore, unless the New Zealand economy decelerates appreciably, rate cuts are unlikely until late 2008 or early 2009.
[B]Will The Commodity Bubble Burst?[/B]
The continued strength in commodities has provided significant support to the New Zealand Dollar and its economy but concerns are mounting that a dangerous bubble is forming. If it bursts the deleveraging of positions will be swift and kiwi could come under assault once again. The market already saw a sample of this volatility in March when the CRB index fell 8.3% in a week. With oil prices hovering at $112 per barrel, wheat prices at record levels and a rice shortage developing, demand for commodities appears strong for the time being. However, IMF’s recent lowering of their global growth forecast to 3.7% from 4.1% and China’s battle with inflation may signal an end to the robust demand for resources from emerging markets. This may present the greatest downside risks to the NZD/USD as a sharp decline in commodities would have an immediate negative impact on the New Zealand economy.
[B]Which Way Will Risk Winds Blow?[/B]
As the U.S. subprime crisis started claiming its first victims in mid 2007, wide spread risk aversion tripped up the Kiwi. The carry trade started to unwind as traders fearing the worst scrambled to cover open positions. Confidence was reestablished by actions by the Fed and other central banks which included rate cuts and liquidity infusion in the billions. The various changes in risk sentiment have seen the pair fluctuate as traders try to get a grasp on whether the worst is behind them or yet to come. The Fed’s recent rescue of Bear Stearns was seen as the turning point in this financial crisis. However, recent rumors of troubles at various European banks and the declining outlook for global growth, has seen the risk aversion theme re-emerge. The recent call for transparency by leaders at the G-7 meetings has many traders nervous that the worst may be yet to come. Especially after the IMF’s recent estimate of nearly a trillion dollars in subprime losses far exceeds the current estimate of $170 billion. If fears start to mount that the full subprime story hasn’t been told, the carry trade will unwind putting pressure on the Kiwi. Conversely, if increased transparency doesn’t uncover further trouble, confidence may be restored for the long-term making the high yielding New Zealand dollar attractive.
[B]Key Points[/B]
Despite the cloudy long-term picture for the economy, the economic backdrop for the Kiwi remains supportive in Q2 of 2008. Commodities continue to make fresh highs, and any sign of a bubble bursting may be a few quarters away. The New Zealand economy has remained insulated from the credit crisis and any fallout from it will need to filter through the global economy before making a significant impact on the country’s economy. Additionally, a strong labor market should be the catalyst for consumers to maintain their current consumption levels, fueling domestic growth. The central banks forecasts for 2008 and 2009 see inflation and unemployment holding their current levels for the remainder of the year with sharp declines heading into 2009. Therefore, for the near-term we expect the RBNZ to maintain the benchmark interest rate at its current record level, with their policy posture becoming increasingly dovish as we move closer to 2009. Until then, the interest rate advantage of the Kiwi will continue to make it a relatively attractive investment amongst its G11 peers. However, the pricking of the commodity bubble, forcing the RBNZ to abandon its high interest rate regime, and further fallout from the credit crisis may rob the currency of its preferred status and set off another wave of liquidation if global growth comes to a grinding halt.
<strong><u>NZD/USD Technical Outlook</em>
Our longer term count for the NZDUSD has not changed. We still expect a significant decline, with price eventually coming under .5927. This decline could take up to a year or more though. The rally from .3897-.7463 was in 5 waves. The decline into .5927 and subsequent rally to .8215 are waves A and B of the large expanded flat correction that we believe is underway. Our best count has wave C underway now from .8215.
