Can the New Zealand Dollar Sustain Its Rally Beyond A 22-Year High?

Extending its impressive rise for the eighth consecutive trading day, the high flying New Zealand dollar has hit a 22 year high above 81 cents. This is the first time that we have seen the currency trade at these levels since it was freely floated in 1985 and the most bizarre part of the move is the fact that it was not driven by any economic data or news.  Compared to the rest of the world, the New Zealand economy is holding up well but unlike Australia, there are chinks in the armor.  A drought in much of New Zealand has spurred a dairy price boom but in the long term, droughts pinch supply which hurts the economy more than it benefits it.  With no economic data released in over a week, yield, risk appetite and commodity prices have been the primary catalysts for the latest move.  Can the New Zealand dollar sustain its rally beyond a 22 year high?  Will the RBNZ intervene again?

What’s Behind the Latest Move?

Uridashi Issuance:  With 8.25 percent interest rates, it was just a matter of time before the move in the New Zealand dollar catches up with the move in the Australian dollar.  Even though there is only a 6 percent chance that the Reserve Bank of New Zealand will raise interest rates at their monetary policy meeting in March, there also seems nearly zero chance that they will be cutting interest rates any time soon.  This has made the New Zealand dollar an extremely attractive investment for Japanese institutional and retail investors who love buying Uridashi bonds, which is debt sold in Japan that are denominated in currencies other than the Japanese Yen.  Even though the Nikkei has rebounded since hitting a low of 12,572 on January 22, the stock markets have been very volatile and the US dollar has been weak, making high yielding bonds more attractive to Japanese investors.  At the end of 2007, there was net negative issuance in Uridashi, but since the beginning of the year, issuances have picked up steam and we have already seen approximately $800 million released into the market. 

Risk Appetite and Yield:  The Dow Jones Industrial Average has rebounded close to 1000 points since hitting a low of 11,634 last month.  Slowly but surely this has led to a return of risk appetite, but the willingness to take on risk has been isolated to the currencies of the countries that are either raising interest rates or keeping them unchanged.  This is why the only currencies that have seen sustainable moves higher against the Japanese Yen are the Euro, Australian and New Zealand dollars.  The rest of the currencies are still trading not far from their beginning of the month levels. 

Drought and Commodity Prices:  Prices for commodities have skyrocketed and New Zealand’s exports of milk powder, butter and cheese exceeded 1 billion for the first time ever in December, up 76.9 percent from a year ago.  This has helped narrow the trade deficit to the smallest in 2 years.  Unfortunately, this improvement in trade has been driven by a drought that hit a large part of their country.  There has been no substantial rain since November and none is expected until April.  Although milk producers are benefitting from higher prices, production has already fallen 30 percent.

Economics Aren’t As Strong As Some May Believe

Part of the reason the kiwi dollar has advanced so consistently is that amid a global downturn in economic activity, the New Zealand economy remains one of the few that has seen expansion supported by both domestic and foreign demand. There is a unique set of circumstances that is working in the island nation’s favor. Foreign demand for New Zealand goods continues unfettered by cooling demand from the major industrialized economies of the world as the country’s exports are primarily agricultural goods – where prices and need have consistently risen. At the same time, domestic consumption has yet to yield any ground despite record levels of debt and interest rates.

The Higher the Kiwi Rises, the More Problematic it Become:  However, considering these particular pillars of growth, it is clear that these trends are living on borrowed time. Exports have been facilitated by booming Asian economies’ need for dairy, meat, wool and other New Zealand-produced goods which have so far outpaced the sharp rise in prices spurred in part by the local drought. This cannot last forever though as China, and the other emerging market nation’s enjoying the draft from the red giant, will likely follow suit with the global cooling eventually. What’s more, foreign demand will also be dampened by the growing costs associated to the unfavorable exchange rates. With the New Zealand currency at 22-year highs against the US dollar, prices for the same goods from global competitors are offered at a natural discount.

Consumer Spending at Risk:  In contrast to foreign demand, domestic consumption is at far greater risk of collapse; and its reversal could have far greater impact on the economy. New Zealand consumers are among some of the most spendthrift in the global economy, supported by unemployment at a record low 3.4 percent and wage growth to match. Despite these underlying trends however, there are a number of economic components that have built pressure behind a potentially sharp economic cooling; and there are a few developing dynamics that may eventually trigger just such a reversal of fortunes. In response to persistent consumer spending in the past, RBNZ Governor Alan Bollard lifted the overnight lending rate to a record last year. While this has yet to correct the booming market, it has led consumers to hold a record level of debt with the highest rates in at least a generation. This means that consumer confidence and willingness to spend are the lynchpin for the entire economy – and sentiment is already eroding. Consumer confidence over the fourth quarter slipped to its lowest level since the second quarter of 2006 according to Westpac. What’s more, the main arteries of support for spending are already falling apart. Business sentiment has been net pessimistic for five and a half years and a fading outlook for exports has weighed employment forecasts. The housing market may also be on its last legs as home sales through December dropped the most on record with high lending rates finally curbing the boom.  New Zealand’s biggest bank ANZ National also reported that delinquent loan payments have risen to $153 million from $94 million a year ago. 

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Watch Out for Intervention and Central Bank Comments  

As the currency rises, the Reserve Bank of New Zealand could be forced to take action. Back in June 2007, the Reserve Bank of New Zealand intervened in the foreign exchange market to sell New Zealand dollars.  This was the first time they have ever intervened since the currency was floated in 1985.  Westpac, one of New Zealand’s largest banks estimates that the central bank sold approximately NZD$120 million which is paltry compared to the Uridashi investments that we have seen since the beginning of the year.  The New Zealand dollar did not top out until one month later which suggests that the intervention did not work.  The RBNZ’s intervention war chest is small so they will be spending their money wisely.  The special fund that they have set up for intervention only has approximately NZD7 billion or USD5.3 billion. 

Finance Minister Cullen also does not like a strong currency.  He has frequently criticized the New Zealand dollar for being overvalued and fresh comments could weigh on the kiwi.  As for interest rates, after raising interest rates back in July, RBNZ Governor Bollard stated blatantly that he would remain hawkish until consumer spending and the housing boom were tempered. As we suggested above, both these milestones are being met. So, while futures markets may not yet be pricing in an impending rate cut, it will only take a remark from Bollard in a monetary policy statement (or in the public forum) that he no longer sees specific inflation repercussions from the housing and consumer sectors to quickly turn the currency around. With the global economy cooling, most central banks easing interest rates and domestic growth trends easing, it seems only a matter of time before inflation eases and the RBNZ steps in to support an unbalanced economy. As we have already been seeing recently, should the kiwi lose its yield appeal the market has a readily available alternative backup in the Australian dollar which is supported by strengthening economic trends and an interest rate that is expected to rise beyond 7 percent.

Technicals:  When currencies are trading at multi-decade highs, it is extremely difficult to find clear resistance levels.  Today’s high of 0.8114 serves as the first resistance point.  The doji formation, which is a sign of exhaustion on the daily charts, is worrisome.  If the New Zealand dollar breaks 0.8060, there is a strong chance that we will see a move down to 0.7950.  On the upside, there is no major resistance until 0.8284 which is the 61.8 percent Fibonacci retracement of the 1.0985 to 0.3906 bear wave that dates back to 1978.  Beyond that we have resistance at 0.8395 which is a congestion zone high from 1981.

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