One Sour Kiwi: Yours! On Another Clip of NZD

As we have discussed in the past, the dollar is finally bottoming. Perhaps the market is finally starting to care about real yield differentials again.

If you thought this dollar move "has legs" to run, what should you short on the other side of the dollar?

I think NZD is a prime candidate to be short.

For those "big picture" and "picture only" people

Let's be lazy and consult the big picture charts - looking at both the weekly and monthly.

On the weekly, we've consolidated since the beginning of the year and look like its ready to run to the downside to at least a 66 handle, or maybe even a 0.62 handle. In the meanwhile, the monthly chart right now reminds me of what materialized in 1999 to 2000.

Fundamentally, why is the Kiwi no longer sweet?

Looking under the hood, I have identified potential fundamental drivers behind this chart.

NZD/USD (and pretty much NZD/anything else) was so strong back in 2013/2014 because RBNZ was the only central bank raising rates to combat inflation post rebuild for the Christchurch earthquake.

That placed the RBNZ on a slightly different policy cycle versus the rest of the G10 world. Since we are looking at NZD/USD specifically let's just focus on the RBNZ vs the Fed.

So the Fed now is raising rates with the US economy ripping while the opposite is occurring in New Zealand.

Most recently, the Kiwi sold off for the most part before, around and after their prime minister election. The weakness in the NZD was very real as it mostly coincided with a general USD sell-off.

Nonetheless, during her first 6 months, Jacinda Ardern has proven to be centrist enough for the NZD to benefit. In addition, the continued decline in USD also boosted NZD/USD levels.

A sour future

At this juncture, the market should understand these dynamics mentioned above. So what can we look forward to?

Well, first I personally believe the USD is bottoming for the tradeable future as noted previously. So there's that. For the sake of this argument, let's just assume the USD bottom and US real yields march higher.

Now, moving on to the NZD side, we've started to see some of the Jacinda Ardern influence on the RBNZ. Ultimately, she is from the Labour party and her leanings to the left will be the driver for a lower NZD.

[Jacinda Ardern] says GDP per capita is "barely growing" and unemployment is stuck at 5% but she says it should be below 4%.
This is because, she says, the economy has become more geared toward speculation and extraction than value-added exports.
"Low wages aren’t simply a problem for low-wage workers, they are a problem for businesses and the economy."
Ms Ardern says under a Labour/NZ First government, "we can finally have fair wages."
From that article excerpt, it is painfully evident that she wants full employment and wage inflation - ya know, kind of your typical cornerstones for high levels of inflation. I talked about this before in an AUDNZD post, but I think the market is finally catching onto this as well.

As predicted, to achieve this, the RNBZ will be the main vehicle. The incoming RBNZ governor has signed off on a new policy objective of caring about full employment along with inflation target. Although he has stated there will be no change in policy bias, I'm not convinced.

With inflation still running on the low side of the central bank's target 1 to 3 percent range, my logic tells me there will not be rate increases coming out of the RBNZ for awhile.

In addition, Jacinda wants unemployment lower! Like 3% lows. Let's take a look.

Assuming this thing stays in the current downward trend, it can still take years of growth and/or stimulative policy before we can get to ~3% unemployment. And trust me, they'll need accomodative policy.

Because when you look at growth:

Regardless of what the IMF thinks they see in their projection, growth to me has started looking like it has become stale and flaccid.

With regard to rates: the OIS curve is still 75bps higher a  year out versus the current RBNZ target rate of 1.75%. This could be too high if you assume they can't raise them and might actually have to lower them.

Subsequently, in REER terms, NZD in a vacuum is still somewhat expensive and could easily depreciate 10 to 15% further before it becomes historically cheap.

All signs point to lower for longer in New Zealand. As a result, even with this latest selloff, I still think there is still money to be made by calling your broker for a quote of NZD and telling him "Yours!"

Good luck as always,

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Click here for comments
April 25, 2018 at 8:07 PM ×

I have spent the last 3 months in NZ and I think your analysis is correct. It is worth mentioning that he Labour party has promised to restrict the sale of farm land and existing housing to foreigners and to cut back on immigration. These have been important ecomomic drivers for NZ in the past.

April 26, 2018 at 12:43 PM ×

Thank you for analysis. I would agree that NZD did look like a long term short from here.

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