The New Zealand dollar was one of the best performing major currencies in the second quarter. Rising by 10.4 percent against the US dollar, the currency pair climbed to a 25 year high.
As a high flying carry trade favorite, the Kiwi was also able to make multi year highs against the Japanese Yen and by the end of the second quarter, NZD/JPY rose to a 19 year high. Having raised interest rates three times this year, with two of those happening in Q2, New Zealand not only has one of the highest interest rates in the industrialized world, but also a growing one. The currency has become such a one-way bet that the Reserve Bank of New Zealand stunned the markets by intervening to sell their currency for the first time ever. This intervention has proved to be ineffective, especially since the central bank has warned of further interest rate hikes to come. As we enter the second half of 2007, traders are still wondering just how high can the kiwi fly.
[B]Higher Interest Rates?[/B]
With the latest inflation report surprising to the upside, there is no wonder why Governor Alan Bollard has remained steadfast in his battle to tame inflation. Having raised rates by 75 basis points already this year, traders may be asking just how high is high enough? For the time being, the case for further rate hikes is supported by consumer spending which increased 1.2% in May, a low unemployment rate and high consumer confidence. Although the report did decline for the second month in a row, the dip was relatively minimal as a longer decline would be needed to signal any type of a slowdown in spending. The most recent monthly report showed a decline to 111.4 for the quarter, down 6.3 points but as long as the index remains above 100, it is considered optimistic. Ultimately, with spending a key driver of the recent spate of expansion, RBNZ Bollard will surely keep to his commitment to lower inflationary pressures. The interest rate curve is currently pricing in a 100% chance of at least one more rate hike by the end of the year.
RBNZ Governor Bollard has also signaled that higher interest rates are to come, but could the central bank be overshooting their own estimates? Although still remaining relatively high, price increases are estimated to decline in the third quarter as production is forecasted to pare back slightly. The notion can be witnessed through the most recent inflationary expectation, estimated to decline to a rise of 1.8 percent. Business confidence is additionally reflective of the output slowdown as outlook surveys have declined considerably, remaining lower in the past couple of months. As an export dependent country, the strength of currency also puts a big drag on the economy. According to the New Zealand Institute of Economic Research, business are also becoming more pessimistic. At this point, further rate hikes may crimp profitability and lead to weaker job growth, which would eventually filter into spending. This of course has not happened yet and in fact spending at the moment remains healthy. Nonetheless it is a serious risk.
[B]Housing Weakness Could Spell Disaster for Economy, Interference By Cullen?[/B]
The only thing that could stop the RBNZ from raising rates is housing. The bubble in the housing market has led to a continued bias towards higher interest rates in New Zealand. For the record, house prices have skyrocketed, with June ringing in the fastest pace of growth in 13 months. Prices have all but doubled in past few years with valuations rising at a 12.2 percent annualized pace in the month. The situation is worse when considering the present situation involving the country?s mortgage holders. In a recent report released by the credit rating agency Moody?s even though approximately 85 percent of New Zealand home owners currently hold fixed rate mortgages, the amount of adjustable rate mortgages to be refinanced next year ($90 billion worth) is still considered large for a country whose population and GDP is less than that of New York City.
The impending outcome would leave homeowners with significantly higher payments, reducing the amount of income at their disposal. Subsequently, this has caused a wave of lower forecasts for the sector with the most notable one coming from New Zealand Finance Minister Michael Cullen. Speaking to a parliamentary committee at the end of June, Cullen noted that the three interest rate increases decided this year would likely spell a “significant downturn” in a 5 ½ year run in the real estate market. “Many people find themselves in a negative equity position” with significantly higher borrowing costs. Ultimately, the reality of the situation would leave spending concerns to the wayside as consumers will likely turn away from making car payments to significantly higher mortgage obligations. Interestingly enough, Finance Minister Cullen could also be the one who puts an end to the Kiwi rally. His concern about the currency market?s one way bets have become so severe that he warned to the markets that as Finance Minister, he has the powers to tell the Reserve Bank to start cutting interest rates because the New Zealand dollar was so overvalued. This power has never been used but if it is, the shift in politics would be construed as very bearish for the kiwi.
[B]Intervention Fears Emerge, Dampens Speculation[/B]
Aside from negative economic fundamentals weighing on the NZDUSD and the possible interference from the Finance Minister, intervention fears have made the Kiwi particularly volatile in recent weeks. The theme may persist throughout the market in the upcoming quarter as investors continue to gauge the likelihood of another central bank intervention. Cued on the basis of precautionary comments made by RBNZ Governor Alan Bollard, the central bank has notably sold the currency in order to stabilize an exchange rate that continues to be “exceptionally high.” The sentiment hasn?t changed in 2007, prompting the Reserve Bank of New Zealand to intervene for the first time ever on June 11, 2007. Since then rumors have circled of intervention by the central bank in two more incidents, attempting to suppress the value of the Kiwi. Should the possibility continue to hang over the currency?s head, traders may be forced to pare back positions in order to control the associated risk, sparking a mild pullback in the New Zealand dollar.
[B]Conclusion[/B]
Although there is plenty of upside potential still remaining in the underlying Kiwi, those days may soon be numbered. Interest rate hike speculation will continue to power buyers on the carry trade side of things with plenty remaining under the belief that rates will likely move above to 8.25 percent by year end. On the flip side, economic fundamentals will keep traders wary of any potential weakness in the currency as they filter through intervention rumors at key technical levels. If anything, the next three months will be an exciting one as the New Zealand dollar will likely succumb to a more neutral stance until stronger directional bias can be established.
[B]Technical Outlook[/B]
We wrote last quarter that “Kiwi traced out a 5 wave decline from the early 1970?s (1.4900) to October 2001 (.3897). A 5 wave advance followed to the March 2005 high of .7463 in what was most likely the A wave of an even larger A-B-C advance to correct the 1.4900-.3897 decline. The decline from .7463 to .5927 was either the B or just the first part of the B wave. A break above .7463 would indicate the former and place NZDUSD in a C wave that is headed much higher (A would equal C at .9493) over the next several years.” There are two counts that we are following right now. One has the rally from .5927 completing a 5 wave rally with wave 1 of that rally as the extended wave. If this is the case, then the NZDUSD must top out before .8009 and undergo a correction before the next leg up. We would expect the correction to end near .7237 before the next leg up. If .8009 is broken, then it is likely that Kiwi is working higher in a wave 3 that is expected to extend to the 161.8% extension of .5927-.7096-.6719 to .8610. Either way, Kiwi looks very bullish over the next year. The only question is whether or not we will see a correction before the next leg up. .8009 is the level to watch.
[B]NZD/USD Weekly Chart (Source: TradeStation 8.2)[/B]
