A Flightless Bird Took Off This Year But Will It Stay Airborne?

by: Joshua Brown


Why all the interest in the kiwi?.

The current drivers and downside risks of the NZD.

The historically overvalued kiwi sets the stage for a fall below the support of NZDUSD 0.85.

The "kiwi." (ENZL, BNZ, LNZD)

The New Zealand dollar is often ranked as being one of the most traded currencies which is somewhat counterintuitive as it represents the 53rd largest economy. The national currency was de-pegged from the US dollar in 1985 and since then it has fluctuated greatly though often trading in a manner highly correlated to the Australian dollar. The government of New Zealand and the Reserve Bank have historically been hesitant to manipulate the price with the last major action taking place in 2007 with the reserve bank selling NZD in order to drive down its value.

The kiwi has seen lows of less than 0.40 USDNZD in 2001 and 0.50 in 2009 and seen highs of 0.88 in 2011, and in recent months we are witnessing a renewed climb to parity with the price reaching 0.87 this month. Analysts often explain the current strength of the kiwi is being derived by the growth of the Chinese economy and strong demand for dairy products. New Zealand is also the first economy to raise interest after the GFC, with the last raise in April to 3%; one of the highest in the western world and acts as a magnet for carry trade funds. There have been recent calls by certain sectors and political parties to intervene in the high value of the kiwi, but as of yet no action has been taken and exporting industries have sustained the rise in their stride. A move to parity or perhaps over 90c would certainly, nonetheless be highly worrisome for the RBNZ and put a brake on monetary contraction.

The idea of a merger or union of the Australian dollar with the kiwi dollar, both highly correlated currencies with shared drivers has long been discussed in order to remove conversion costs, build economic strength and financial power. It would seem New Zealanders are most in favour of this union (as Australia is its main trading partner) and as the currencies move towards parity, this option may garner further consideration. A common currency would also create a trading bloc that would increase the wealth of small pacific Island states that would most likely also adopt the new dollar. At the moment, this idea may not be so palatable after the euro experience; however, US economics professor Barry Eichgreen of the University of California says it is worth examining and so it should be more seriously debated in the coming years.

Another reason why the New Zealand dollar is one of the most highly traded currencies is because it represents an economy that is the first to trade after the close of the US markets. Due to its geographical timezone, New Zealand markets are the first to digest and react to American events and released data and often global markets will follow its lead. While other markets are closed, the New Zealand dollar will be the only currency trading with any volatility.

Drivers of the kiwi

The New Zealand economy was forecast to outperform its developed market peers at the beginning of the year and indeed it has met that expectation. Strong demand of its exports, such as dairy and wool, rose in China and Australia - its largest trading partners. This lifted the economy despite interest rate hikes reducing investment spending.

Other factors bringing value to the kiwi comes from a large wave of immigration that has led to a housing and construction boom. This includes the residential investment in re-building Christchurch following the earthquakes of 2010 and 2011 that devastated the region. Tourism is also up with annual growth of 5% and tourism expenditure is rising to 9%. Small businesses are considered to be a large driver of economic growth with New Zealand rated as being one of the best places in the world to do business.

Along with the Australian dollar, New Zealand is also an attractive destination for the investment funds of a newly cashed up Chinese middle and upper class who are now able to invest their funds abroad. The relatively high NZ and Aussie interest rates plus the depreciating yuan have caused the Chinese to park their funds in this stable pacific region.

Potential downside forces of the kiwi

  • The New Zealand dollar is considered to be overvalued by many analysts. Here are some of the reasons why:
  • The Kiwi is exposed the economic uncertainty of China. A drop in exports will lead to a drop in kiwi demand.
  • High interest rates will reduce investments which in turn offsets the growth of the economy and private consumption.
  • A reduction in the prices of dairy and cattle products such as wool and meat.
  • New Zealand sits upon an unstable geological fault line. This fault line is a potential hazard for some of the largest New Zealand residential areas such as Christchurch and its capital Wellington. The country is also vulnerable to droughts and naturally occurring phenomena.
  • The demand for exports might be hampered by the strong New Zealand currency and would in turn widen the current account deficit, despite the best efforts of the Government to reduce it (by reigning in spending).
  • The rise of foreign interest rates may pull funds away, however, this risk seems to be some time off.
  • A reduction in Asian investments as the Chinese economy slows. We might even see a reversal as Chinese debt rises or growth drops to a point where investors becomes risk averse and want their funds situated closer to home.

A New Zealand dollar outlook

It would appear that the kiwi is trading at historical highs and technical indicators say the currency is overbought over NZDUSD 0.85. Strong resistance lies at 0.87, 0.88 and good support lies at 0.85, 0.80 and 0.77. The moving average is still rising, but it's hard to see how there is enough upwards pressure to see the currency reach parity with either the AUD or the USD considering the NZD has probably priced in all favourable conditions. We should enter a period of price stability with movement between 0.87 and 0.80 and this opens up the currency to profitable range trading opportunities. In the near future, we should see a retracement to ~0.81 should the currency drop below 0.85. After the recent increases of the interest rate, the reserve bank will probably wait to see its effect on the economy before taking action again. On the other hand, the US continues to contemplate how and when it will raise rates and therefore at the current rate of 0.856, the downside risks are stronger than upwards momentum. We at the Alpha Generator make this New Zealand dollar prediction with a downside bias, but a drop below the support of 0.85, would crystallize this opinion.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.