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NZD/USD Could Continue To Fall After Year-End Spike

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Includes: NDO, NZDOWD, UDN, USDOLLAR, USDU, UUP
by: Hedge Insider
Hedge Insider
Long/short equity, value, macro, volatility
Summary

The NZD/USD has risen significantly recently, especially into the year-end of 2019.

The New Zealand dollar has however fallen into 2020, dropping by about 50 basis points per day for two consecutive days.

Further downside is likely, due to lesser influence of past factors favoring upside (an unwinding of high short positioning, global portfolio rebalancing, lower levels of liquidity over the holiday period).

Going forward, as the NZD has risen substantially against its trade-weighted index, and even further against the USD (paying attention to the 100-day moving averages), a downward adjustment is likely to (continue to) occur.

The market is likely to favor NZD weakness in the near term as we move through January 2020.

In a recent article of mine, I wrote that the upside as seen in the NZD/USD pair was likely to be limited (or "capped"), given its surge relative to the 100-day moving average of the New Zealand dollar's trade-weighted index. The price then was 0.6700; the New Zealand dollar was then able to continue its rally against the U.S. dollar to a high of 0.6756 on the last day of the year.

However, more recently, the pair has fallen substantially back under the 0.6700 level, most recently marking an intraday low of 0.6644 on January 3, 2020. The daily candlestick chart below illustrates this recent price action; the two most recent days saw the pair fall about 50 basis points for two consecutive days.

NZD/USD Daily Candlestick Chart(Chart created by the author using TradingView. The same applies to subsequent candlestick charts presented herein.)

As shown, the pair was not quite able to meet the highs of July 2019, which saw NZD/USD trade at over 0.6790. The problem, as discussed previously, was the sheer extent of the rise relative to the trade-weighted index. Whether through non-explicit central bank intervention, the mere threat of intervention, and/or traders attempting to "front-run" (or simply fear) the possibility of intervention (to stem the strength of the NZD) can be enough to weaken the currency.

The trade-weighted index of a currency measures the value of a currency against a basket of other currencies, typically in proportion to the level of trade that the country (whose currency is in question) has with its partners. For example, the more trade a country has with the United States, the greater the weight of the USD will be in that country's FX trade-weighted index.

Trade-weighted indexes are often watched by governments, including central banks, as sharp moves can have real-economy consequences. The more the trade-weighted index (or TWI, for short) rises, the more expensive the country's exports are from an international perspective. The more expensive exports appear to be, the less competitive they are.

The NZD is considered a commodity currency; this is due to the country's exposure to exports, especially milk (dairy). Because of the importance of New Zealand's export market, the international strength of the NZD is important for the Reserve Bank of New Zealand (the RBNZ) to monitor.

After all, as a central bank, the RBNZ is interested in maintaining regional price stability (domestic inflation), and reducing "economic volatility". Imagine a country using a volatile currency like Bitcoin as its primary currency; the volatility would be highly disruptive to businesses with respect to the making of long-term investments, business planning, etc.

In short, while we cannot always know how central banks will intervene (if at all), their influence (or potential influence) has, well, an influential effect on markets. The chart below, created by the author using data sourced from the RBNZ directly, shows us the New Zealand dollar's TWI versus its 100-day moving average (red line), and also the NZD/USD pair against its 100-day moving average (orange line). Horizontal lines have been added to indicate recent highs in the period shown (i.e., since at least mid-2018).

NZD/USD vs. TWI and USDAs we can see, the "ratio" (between the NZD TWI and its 100-day moving average) almost hit the 3.99% again most recently, although it has shifted downward into 2020. Meanwhile, against the USD, the NZD has actually far exceeded the highs of late 2018 (to 5.05% above its 100-day moving average, versus about 4% in late 2018). This exceptional rise is likely to be met with further downside. A further reduction in price volatility should, if history repeats, see the NZD/USD pair fall to its 100-day moving average within about one month or so.

The chart below shows the current 100-day moving average (per the blue line) at the level of 0.6417. While this itself could continue to tick up, it is likely to remain roughly in line with this current level in the short term (under 0.6500). Therefore, we could absolutely see NZD/USD fall to this level in the near term, to between 0.6450 and 0.6500. This is not to say that the NZD cannot rise higher, but long positions would be advised against in the near term.

NZD/USD vs. 100-day Moving AverageThe recent surge in the price may have also been owing to the high level of short positioning in the NZD currency as of late (these short positions unwinding, sending the NZD higher), as well as lower levels of trading liquidity in the latter part of the year of 2019 (the Christmas holiday period).

We may also have just witnessed some significant portfolio rebalancing effects, as U.S. stocks have out-performed most global indices recently; this could have been a significant reason for the end-of-year USD weakness. I touched upon this in my recent EUR/USD article.

In summary, at least some of the likely factors that sent the NZD higher recently are either much weaker or no longer present (e.g. fewer 'short NZD' positions; a return to higher levels of liquidity, subsequent to the holiday period; no more end-of-year rebalancing moves; etc.). Meanwhile, the recent NZD price surge presents an ongoing risk of NZD weakness, whether through explicit central bank intervention, non-explicit (i.e., "non-public" intervention, without an official statement) and/or a fear-driven fall in the NZD (driven by concern for potential intervention or otherwise a cessation of the recent speculatively bullish trend).

The NZD/USD could see 0.6450 to 0.6500 in the short term (over a one-month period). If the NZD strength continues, the pair may be able to sustain itself above 0.6600. However, given the extent of the recent surge, it is probably unlikely that the pair is able to completely avoid a steady re-adjustment downward in the near term, and hence there would appear to be a short-term asymmetry of risk in the near term, favoring further downside in NZD/USD.

Disclosure: I/we 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.