Currency of the Month – The New Zealand Dollar

Despite sharing its nickname with the native flightless bird, the New Zealand dollar has been anything but grounded since the end of the 2008 U.S. financial crisis. Similar to many emerging market currencies, the New Zealand dollar, or Kiwi as it is known to traders, burrowed for refuge during the U.S. credit financial crisis as global markets took shelter in the relative safety of U.S. dollar holdings.

Notwithstanding a brief setback after the devastating 2011 Christchurch Earthquake in the populous Canterbury region of New Zealand, the kiwi has leveraged strength from its exporting commodities and domestic consumption to steadily gain against the U.S. dollar since 2009. (Figure #1) The question, of course, is whether the New Zealand dollar can take the strength of its rugged topography and hardy people to buck recent strength from the U.S. dollar. This month’s Currency of the Month looks at the fundamentals and value in one of the more interesting emerging market currencies, the New Zealand dollar.


Source: EverBank Research Team, based on analysis of data released by The Reserve Bank of New Zealand and the St. Louis Federal Reserve (FRED). These values are illustrative only and do not necessarily reflect retail exchange spreads or other transaction costs.

As an island nation, the New Zealand economy relies heavily on the import and export of goods and services, so inevitable volatility in the trade deficit has historically been a concern for investors considering the New Zealand dollar. As such, the New Zealand government maintained judicious economic practices in targeting stable budget surpluses between 1994 and 2008 (Figure #2).


Source: EverBank Research Team, based on analysis of data released by the New Zealand Treasury. 

Additionally, the central bank has historically preserved relatively high interest rates in order to both keep inflation below its 2% target given the risk of inflation importation, as well as to help attract external capital investment. (Figure #3)


Source: EverBank Research Team, based on analysis of data released by The Reserve Bank of New Zealand. 

Not surprisingly, the New Zealand monetary authorities abandoned both mandates for higher rates and balanced budgets in the wake of the 2008 financial crisis, in response to the Christchurch earthquake, and in light of the crowd wisdom for greater global liquidity by implementing emerging rate cuts and running atypical spending deficits. Nevertheless, given the New Zealand central bank’s desire for higher rates, the recent tightening in credit by the bank may be an indication for even higher cash rates despite an otherwise global race to zero rate bounds, as it appears as though the central bank is on track to begin removing the accommodative monetary policy.

No Grounding For This Bird

The March 2015 Monetary Policy Statement from the Reserve Bank of New Zealand cites a number of positive trends for the New Zealand economy, most notably the year-over-year drop of 50% in oil prices providing increased consumer purchasing power and a reduction in the cost of business operations.1 The report additionally references higher net immigration, business investment and a rebound in housing construction as net positives for economic activity.

Recent strength in the currency, particularly versus the kiwi’s closest relative, the Australian dollar, has similarly improved purchasing power for imported products. Based on improvements in the New Zealand economy as well as downward pressure on the Australian dollar, investors have seemingly been swapping positions into the New Zealand dollar to collect higher yield differentials. The market’s expectation for a lower rate environment from the Reserve Bank of Australia has brought the Kiwi to within a feather of parity with the Australian dollar, and its highest level relative to the Australian dollar since the floating of the New Zealand dollar in 1985.2

Additionally, New Zealand’s large export commodities of lamb, meat, pelts and wool have benefited from aggregate decades-high pricing3 based on demand from China and a stronger U.S. dollar. Market intelligence further confirms that New Zealand ewe production appears to be on the rise, in terms of both weight and birth number, which would be a further positive data point for the New Zealand economy given the four-year highs in wool prices, New Zealand’s 14th largest exporting commodity,4 in addition to the aforementioned elevated meat prices.

Conversely, the Reserve Bank of New Zealand similarly notes some areas of concern for the economy, most notably the ongoing drought conditions in the southern portion of the island that could reduce dairy incomes.5

However, the larger near-term risk for the currency, in my view, may, in fact, be persistent jawboning by the current Governor of the Reserve Bank of New Zealand, who has made his position clear that he is no fan of strengthening in the kiwi. Governor Wheeler has thus far avoided following recent global trends in further monetary accommodation by reducing New Zealand’s benchmark rates, which remain at least 100 basis points higher than most other industrialized nations, although the Governor has not been averse to intervening in the currency market as evidenced by the August 2014 sale of $389 USD million in New Zealand dollars by the Reserve Bank of New Zealand.6

Yet, as we have regularly observed when faced with government intervention in the currency market, it is a difficult task to keep a bird from flying – even an earthbound kiwi.

Outlook For The New Zealand Dollar

Despite calls by the current central bank Governor to weaken the currency, this appears to be an unlikely scenario given New Zealand’s persistent vigilance on inflation. Granted, global inflation is running relatively low, at present, thereby providing some cover for the New Zealand Reserve Bank to reduce rates. Yet, much of this downward inflation pressure is due to the drop in volatile global oil prices. It is more than likely that without the fall in oil prices, the New Zealand Reserve Bank would instead be in a position of tightening interest rates. Given the current yield advantage that the kiwi provides, investors with positions in the New Zealand dollar would appear to be sitting in the catbird seat when oil prices do rebound.

Conversely, the Reserve Bank of Australia (RBA) has recently shown more willingness to cut rates in the present environment, especially after surprising the market in February 2015 by electing a 25 basis point reduction in overnight cash rates.7 Lower rates from the RBA would also seemingly be positive for the kiwi, as investors tend to view the two currencies as substitutes, particularly with the benefit of a 125 basis point-yield advantage for investment in the New Zealand dollar.

However, the true value in the New Zealand currency may be in the resilience of the domestic economy and the value of its commodity exports to emerging Asian markets. Increased immigration and low mortgage rates have helped support a 6.5% advance in housing inflation, spurring increased housing construction activity within the domestic economy.8

Economic activity in New Zealand’s important export partners throughout the emerging Asian region, but especially China, which represents 15% of the country’s export activity,9 is expected to expand at just under 6%.10 And, as mentioned previously, pricing for meats, pelts and wool remain at multi-year highs. As such, economic growth in the New Zealand economy is anticipated to advance between 3% and 4% over the next two years.11 In a global market where central banks are wont to lower interest rates and maintain accommodative monetary regimes, the New Zealand central bank may be in the unique position where a tightening of monetary policy may be more likely, particularly if oil prices rebound in the near future.

Investors should be mindful, however, that investment in emerging economies is an inherently risky proposition, and should only be considered for those investors whose risk profile, capacity for risk, and time horizon is appropriate for speculative investments. Risks including market volatility, geopolitical, sovereign, governance, bankruptcy and liquidity can be amplified with investments in emerging markets, and should be strongly considered when determining exposure and position sizing for a properly diversified portfolio.

Nevertheless, in a market where a strong dollar has all but dominated most other currencies, perhaps investment with a bird flying in a tailwind may be the answer for suitable portfolios.