The Quest For Yield: A Perspective On New Zealand Dollar ETFs

Includes: AUNZ, CCX, ENZL
by: Robert Okada, CFA

Searching for yield overseas, but can’t stomach the idea of historically low and negative real (inflation-adjusted) interest rates in most developed (G10) economies, such as U.K. or German 5-year government bonds at 1.06% or 0.94%? Or, perhaps you’re not yet comfortable with the liquidity aspects of higher-yielding emerging market local currency debt with stronger fiscal accounts and favorable debt metrics?

As an alternative to these options, New Zealand offers enticing yields and numerous investment opportunities for the personal and professional investor. For example, New Zealand 5-year government bonds and 3-month T-bills yield 3.62% and 2.70%, while a bank savings account at a top-tier bank pays as much as 4%. Comparatively, here in the U.S., equivalent U.S. Treasuries pay 0.88% and 0.005%, while a Bank of America savings account pays a paltry 0.35%.

Given New Zealand’s relatively alluring yields, is an investment down under worth the risk? Let’s examine the kiwi dollar and determine whether it is figuratively a flightless bird or a rising All-Black. After a briefing, we will look at key factors that undermine the NZ dollar, and then highlight attributes that are both supportive to the currency and unique among developed market currencies.


The New Zealand dollar (CCX, AUNZ, MERKX, MABFX, ENZL) has been a notorious high yield currency since it was floated and began trading freely in 1985. New Zealand’s real long-term interest rates, for example, have been high historically among developed countries, offering an average premium of nearly 4% (1997-2010), thus making the NZ dollar a preferred destination for global investors seeking higher yields overseas. Currently, real long-term interest rates average 2.07% and look attractive when compared to negative real yields in both the U.K. and U.S. (keep in mind that investors should demand a premium to compensate for currency, liquidity, sovereign and inflation risks).

However, over the past year, the country has been hit with a number of shocks to both its economy and currency: two massive earthquakes leveling Christchurch, its second largest city; a fall-off in commodity prices; a sell-off in global stocks; and a credit rating downgrade of its foreign currency debt. Subsequently, the kiwi dollar has dropped 13% since August 1st, while interest rates have fallen to historically low levels both nominally and when compared to inflation.

Factors That Undermine the NZ Dollar

Bloated and Temporarily Hobbled Kiwis

New Zealand, like the U.S., has an extremely high level of both public and private sector debt, in excess of 330% debt to GDP. ^ (Note: 93% of NZ’s overseas foreign currency debt is hedged back to local currency, and therefore minimizes large foreign currency mismatches, such as what happened to ASEAN* countries during the ’97 Asian Financial Crisis).

According to New Zealand’s Finance Minister Bill English, the cost of the two recent Canterbury region earthquakes will result in a fiscal deficit of NZ$18 billion (-9% of GDP). This cost is an intermediate-term negative, but the Treasury forecasts that the reconstruction of Christchurch will provide an additional 1.5% annually to GDP growth through 2014. Regardless of the short-term stimulus, a highly leveraged NZ economy in a debt-gripped world is both a short-term negative and long-term risk to currency investors.

Kiwis Love to Borrow and Spend

New Zealanders simply spend more than they lend or save. To cover the differential, real interest rates must stay comparatively high to attract investor monies from overseas. The country’s current account deficit, averaging over 5% per year between 1980 and 2009, is expected to worsen over the next five years, from a current 2.25% to 7% of GDP. As the gap widens, investors can expect relatively high interest rates to fund the deficit. (Recognize that a high current account deficit is most often considered a fundamental negative, but as it relates to the NZ dollar, relatively high real interest rates as a result of the deficit have been a boon for currency investors).

Inflated Property Prices

New Zealand’s housing sector is estimated by the IMF to be 15-25% overvalued. A sharp fall-off or sustained weakness in housing prices, combined with high current levels of household debt (e.g. near 170% of disposable income), would weaken further already subdued levels of domestic consumption, resulting in no significant contribution to overall growth. To put this risk in perspective, an OECD** report highlights that housing prices in major urban areas such as Auckland and Wellington, where 86% of the population resides, appreciated in real terms over 200% from 2001 to 2007, and have declined only modestly since the financial crisis. By comparison, this same report shows that only Spain and Australia had a higher overall level of appreciation during that time period. Since then, Spain’s housing prices have declined dramatically, while Australia’s are falling at a relatively slow pace.

In addition, Kiwis hold a disproportionate amount of wealth in housing and land - over 75% of total assets, which is significantly higher than the 50% average among households in the 14 OECD countries. In aggregate, a debt-laden NZ household sector, whose wealth is mostly tied up in real estate, represents considerable risk to an overleveraged economy in an environment of heightened sovereign risk and falling asset prices.

U.S. Stocks Disguised As A Kiwi Dollar

The NZ dollar tends to act like a U.S. stock. When the VIX index of U.S. stock market volatility rises, the NZ currency drops in tandem with U.S. share markets, providing little respite for currency investors. Moreover, when high-yield corporate bond spreads widen, the NZ dollar trades lower. So, in a “risk-off” or risk-averse environment, such as what we’re experiencing now, the NZ dollar sinks and offers little to no currency diversification benefit.

Falling Agricultural Commodity Prices

Exports account for about 24% of New Zealand’s GDP, with dairy and meat products being the top two earners. Therefore, sustained weakness in agricultural commodity prices represent sizable risk to an already weak economy that is barely growing at 0.1%.

Factors Supportive to a Strengthening NZ Dollar

NZ Offers relatively High and Positive Real Interest Rates

Because of the current crisis in Europe, investors have sought liquidity not only in 10-year U.S. Treasuries but also in equivalent U.K., Canadian and German Government bonds, thus driving yields to all-time lows. To put this yield grab in perspective, 10-year New Zealand Treasuries trading at 4.07%, when combined with “inflation settling near 2%," as recently stated by Reserve Bank of New Zealand (RBNZ) Governor Alan Bollard, offer a real yield premium of 2.07% over their advanced country counterparts.

Furthermore, 3-month NZ T-bills yielding 2.70% or a bank savings account paying 4%, compare favorably to the above-mentioned countries’ short-term securities, and provide a real yield advantage of between 0.70% and 2%. Among advanced economies New Zealand is one of few countries that offer high relative real interest rates in which to invest one’s dollars.

U.S. Files Complaint Over Chinese Chicken Tariffs” (click here for story)

New Zealand is the only developed (and OECD) country to have completed a free trade agreement with China. Therefore, you won’t see such similarly provocative headlines related to the kiwi dollar as you sit over morning coffee. Mainland China now represents the second largest and fastest growing destination for NZ exports. In addition, China is the largest importer of dairy products, a commodity which represents about 25% of New Zealand’s total export earnings.

What makes this figure significant is that China currently has one of the lowest per capita consumption rates of dairy in the world, yet already accounts for a quarter of New Zealand’s total export revenues. So, any inevitable increase in real disposable income in China will have an even larger and more significant impact on NZ’s export revenues, helping to bolster the NZ dollar. As further evidence of China’s growing appetite for dairy products, the Puget Sound Business Journal reports that the state of Washington’s biggest export to China in volume terms is none other than high-quality hay for dairy cows. Some observers may say this development could hurt NZ dairy exports. However, New Zealand’s comparative advantage as a dairy producer and rising Chinese consumer spending, which declared by McKinsey & Co. is expected to double by the year 2020, provide NZ with an increasing and consistent source of future revenues supportive of the kiwi dollar.

Greater Fiscal Space or “Financial Flexibility” among Advanced Economies

In a 2010 research paper, Ken Rogoff and Carmen Reinhart indicate that a 90% debt to GDP ratio is the tipping point at which government debt has a meaningful and negative impact on a country’s growth. Currently, New Zealand’s government debt to GDP stands at 36% and is relatively low among developed economies. Additionally, in a report from the IMF, New Zealand is one of five advanced economies that “have the most fiscal space to deal with unexpected shocks." So, in an environment of elevated sovereign risk, New Zealand’s greater relative fiscal maneuverability and high real yields provide a reasonably attractive destination among mature economies.

Higher Inflation Is Good News for the NZ Dollar

The NZ dollar, unlike the U.S. dollar (UUP, UDN), is unique among advanced economies because the exchange rate tends to appreciate when inflation surprises to the upside. According to the RBNZ, bad news on New Zealand’s domestic inflation rate is good news for the NZ dollar in a rising exchange value. Conversely, when U.S. domestic inflation surprises to the upside, the U.S. dollar depreciates. Therefore, central banks led by the Fed and ECB, which continue to flood already flush markets with excess liquidity, will help underpin commodity price inflation. If history is any guide, higher prices would be supportive of the NZ dollar.

“The best place to buy a market is near support levels. That support is usually a previous reaction low.” (Technical Analyst John J. Murphy, from his Ten Laws of Technical Trading)

Technically Speaking

Caveat Emptor: In early August 2011 the NZ dollar broke an uptrend dating back to June 2010, when the currency rose 34% from a low of .6584 to an all-time high at .8832 USD/NZD. Since then, the currency has dropped 13%, in tandem with a rise in the VIX index of U.S. stock market volatility. The currency appears to have formed an intermediate-term top by having twice failed to hold above the 200-day moving average (MA) at .7950, while the 50-day MA has crossed below the 200-day MA. Near-term support lies at .7499, which is the recent low coinciding with the October 2011 spike low in the S&P 500 at 1074.77. A breach of .7499 would indicate further downside to .7174, which is the reaction low to the second Christchurch earthquake in March 2011. Surrender of these levels would indicate a more negative tone and aim toward .7000.

“Global re-easing is underway ... the Fed, the ECB, the BoJ, and the BoE have all delivered. The result? An increase in the G5 excess liquidity metric.” (Morgan Stanley Global Economic Forum, 11/07/2011)

“Four strong market forces will put downward pressure on the (U.S.) dollar during coming years.” (Economist Martin Feldstein, 8/1/2011)

In summary, within a context of excess global liquidity and a secular decline in the U.S. dollar, the NZ dollar provides investors with a higher yielding equity-like substitute, a partial hedge against inflation, and exposure to higher dairy, meat and wool prices. Because the NZ dollar offers higher yields among most advanced economies and is both positively correlated to U.S. stocks and rising inflation, the currency can be creatively viewed as a hybrid vehicle, exhibiting characteristics of debt, equity and physical commodities.

With interest rates in most advanced economies at or near historically low levels, and when combined with inflation result in negative real yields, it makes sense longer-term (when exchange rates are favorable) to focus on currencies that offer: higher relative real interest rates; exposure to both rising commodity prices and China’s insatiable appetite for agricultural products; and protection against rising inflation. Among developed economies, the NZ dollar is one of few currencies that has all four characteristics.

However, in a world where debt is the devil, New Zealand’s extraordinarily high level of private sector debt offsets many of its positive attributes, making the currency a higher risk bet. Therefore, it’s prudent to take a more diversified approach to the NZ dollar.

As an alternative to a concentrated position in the currency, several fund managers including WisdomTree, iPath/Barclays and Merk Investments offer exposure to the NZ dollar as part of a basket of higher-yielding currencies. For illustrative purposes only, WisdomTree’s Commodity Currency fund (NYSEARCA:CCX) provides exposure to the NZ dollar, while holding a near equal weighting in seven other commodity-based currencies that, in aggregate, offer each of the aforementioned qualities. Because the fund provides exposure to money market rates in each of the eight respective countries, this ETF will provide you broad currency exposure with limited interest rate risk.

*(ASEAN) Association of Southeast Asian Nations

**(OECD) Organization for Economic Co-operation and Development

^Data: RBNZ,,,

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.