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BNZ sees downside risk to kiwi already trading below fair value estimate

Thursday 5th July 2018

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Global risks coupled with domestic forces are weighing on the New Zealand dollar and Bank of New Zealand says its fair value estimate of 70 US cents faces downside risks that could push it even lower. 

"The biggest near-term risk we see for the NZD is the ongoing pressure seen in emerging market asset prices," which has coincided with a recovery in the US dollar, says senior markets strategist Jason Wong. 

He said domestic forces are also negative for the kiwi dollar and New Zealand monetary policy continues to act as a headwind for the currency, noting the market is now pricing in a small chance of a rate cut over the next six months. While "we don't think the bank will cut rates, the near-term risks slightly favour a rate cut than a hike over that timeframe, adding to downside pressure on NZD," he said.

Also, "the domestic data flow hasn't exactly been encouraging for the NZD," he adds, pointing to gross domestic product growth that is barely positive on a per capita basis and the ongoing weakness in business confidence as "current profit expectations suggest considerable downside risks to our growth forecasts."

Wong said BNZ's risk appetite index has fallen to 56 percent, which is down to the lower end of the range seen over the past 18 months, that New Zealand commodity prices have fallen from cyclical highs and that spread on the NZ-US 1-year swap rate has fallen close to zero.

"We see the outlook for all the model drivers to the downside," he said. In a more uncertain global outlook with escalating trade wars, "risk appetite probably deserves to trade lower."  New Zealand agricultural prices have significantly outperformed global prices and the latter should ultimately enforce a downside bias as NZ pricing comes back in line with international peers. Finally, rising US short-term interest rates will become more attractive relative to static New Zealand rates. 

Assuming a 10 percent fall in New Zealand commodity prices, BNZ's risk appetite index falling to a slightly below average 46 percent, and the NZ-US rate spread falling 50 basis points, the model-driven fair value estimate would fall to 66.50 US cents, from 70 cents, he said. 

The kiwi traded at 67.63 US cents as at 1:40pm in Wellington. 

The International Monetary Fund this week also said New Zealand's Real Effective Exchange Rate, or REER, remains above its long-term average, despite recent depreciation and the "New Zealand dollar is moderately overvalued."

BNZ's Wong said, however, there are also good reasons to not become "overly bearish." While commodity prices may ease, New Zealand's terms of trade will likely remain close to a record high and the recent soft data is expected to be temporary as fiscal stimulus helps support growth over the second half. Inflation will begin to emerge and "some higher inflation data could easily change perceptions about the next move by the RBNZ, helping to eventually support the NZD," he said. 


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