Currency Research. NZD 2017 Roadmap. Strategy. 19 January Short-term upside potential to NZD/USD. research.bnz.co.nz Page 1

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Jeremy Mason
5 years ago
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Currency Research Strategy 19 January 2017 NZD 2017 Roadmap The NZD has shown signs of recovering early in the New Year and it still looks over-sold on our short term model, which has seen fair value

Political risk will be a core theme for currencies this year, with a new government in the US, elections across the key euro-area nations, Brexit risks for the UK, China s 5-yearly leadership

1 Currency Research Strategy 19 January 2017 NZD 2017 Roadmap The NZD has shown signs of recovering early in the New Year and it still looks over-sold on our short term model, which has seen fair value lift to USD0.74. We are positive on the Kiwi over the short-term but headwinds are expected to ultimately emerge through the year. Political risk will be a core theme for currencies this year, with a new government in the US, elections across the key euro-area nations, Brexit risks for the UK, China s 5-yearly leadership congress, and NZ s own general election later in the year. US monetary policy is out-of-sync with the world, with a tightening cycle underway. The RBNZ could well be the next key central bank out of the blocks later this year, while tightening prospects remain more distant than that for other major central banks. This dynamic is currently positive for NZD on the non-usd crosses, although as expectations evolve it won t remain that way all year. Domestic currency drivers are positive for the NZD, although not as positive as last year, with growth momentum expected to fade as the year progresses and the terms of trade close to peaking. As the New Year gets underway and we think about the year ahead we remain constructive about the NZD. Last year the USD was a strong currency and most currencies weakened against it, but NZD/USD eked out a 1½% gain. The NZD appreciated by 4½% on a TWI basis after rising on 13 of the 17 crosses that make up the index. Our view on the NZD for 2017 is more one of consolidation, at a strong level, rather than making a lot of further headway this year. The early part of the year could see the NZD making fresh highs on some crosses. The global and domestic backdrop starts the year on a positive note for the NZD but we think headwinds will ultimately emerge and hold back the performance of the NZD. By the end of 2017 we have the NZD flat to down slightly on most of the crosses relative to current levels. Short-term upside potential to NZD/USD Our short term view on NZD/USD is positive. The year began with NZD/USD oversold on our short-term fair value model. Our model estimate has moved up to its highest level in about a year, driven by high levels of risk appetite and rising NZ export commodity prices, and currently sits just under the USD0.74 mark. NZD Trading Cheap on our Short-Term Model Net speculative positioning data (with a more than oneweek lag) show net short NZD positions at their greatest level in 18 months and amidst a general picture of long USD positions, although some shorts would have been squeezed out this week. Thus, at least from a positioning perspective there s a fairly low hurdle rate for the NZD to bounce higher over the short term. A variable which our model doesn t capture is the heavy sell-down of Asian currencies and China currency concerns, with Trump s trade rhetoric and the risk of global trade wars a prevailing factor. This dynamic has dragged down the NZD in the process. Asian currencies have potentially been oversold as well so any near-term recovery would be NZD supportive. NZD Dragged Lower by Asian Currency Dynamic NZD/USD Short-Term Fair Value Model NZD/USD Model estimate 120 NZD/USD vs Asia Index/USD 115 NZD/USD (rhs) Asia*/USD (lhs) 100 * Weighted average of SGD, KRW, TWD, THB, PHP, MYR 95 research.bnz.co.nz Page 1

2 Lots of questions beyond the very near term Beyond our short-term view, some key questions that could set the tone for the year and impact the NZD and the crosses are: How many times will the Fed hike rates this year? Is global inflation at an inflection point with the disflationary era drawing to a close? Will Trump really go down the track of trade wars? How will the UK-EU negotiations go on Brexit? How much weight should be put on European political risk? Will China s capital controls stem the outflows or will it be forced to allow market forces to take over? What s the timing of the first RBNZ hike? Is the RBA likely to ease again? Any currency strategist needs to formulate some answers to these questions along with views on a range of other variables. Easy-peasy. Political risk remains a currency theme Politics turned out to be a key driver of markets last year the UK s vote for Brexit and Trump s surprise election victory were significant market-moving events. This year politics will feature again. In the US, Trump s policies on trade, regulatory reform and tax reform will reflect political decisions. The market currently assigns little weight to trade wars, which would be a risk-off development, and is betting on regulatory and tax reform as likely positive developments. A change in the balance of opinion here could easily impact the USD. Post this weekend s inauguration of the new President, the market will be expecting more detail on policy, aligned to the pre-election rhetoric. In the euro-area a series of elections this year overhangs the euro. These include the Dutch general election in March, French Presidential election in April-May and Germany Federal elections in September-October. Italians also could be required at the ballot box again, given the precarious state of politics in Italy. Our projections incorporate some politically-induced risk for the euro early in the year that takes NZD/EUR up to. If we re wrong and these elections pass without much fear, then the euro would be much stronger than our current projections, which would see NZD/EUR back down towards. Our year-end target is actually 0.64, as political risk fades later in the year and the fundamentals (eg an outlook for ECB winding down its asset purchase programme next year) take over. Political risk also overhangs GBP, with the two-year process of exiting from the EU likely to be triggered by the end of March. We ve already seen GBP hit this year as the timeline approaches only to subsequently recover as PM May laid out her vision. One thing we can be certain about is heightened GBP volatility as the Brexit negotiations take place. Our projections incorporate further GBP weakness as the negotiations begin and the economy takes a hit on the uncertain outlook, before a recovery ensues. Our NZD/GBP projections are contained within this year, with the risk of blowing up through at some stage if Brexit negotiations take a turn for the worse. Political risk rises through 2017 for NZ as well, with the next general election likely around September/October. Economic confidence could well weaken in the lead-up to the election as the likely shape of the next government becomes clearer. There might be times when the NZD is impacted by local political developments, more likely to be negative than positive. Monetary policy Last year expectations of Fed policy were a key driver of currency markets and this year is unlikely to be different. Experience over the past couple of years has been for the Fed to project a number of rate hikes at the beginning of the year, only to end up not delivering. We saw that at the beginning of 2015 and 2016 when four rate hikes were projected by the FOMC for the year ahead, with only one rate hike delivered each year. At the beginning of those years market pricing was sceptical of the extent of those projected hikes but the lack of tightening still surprised to the downside. The year 2017 begins with the FOMC projecting three rate hikes and market expectations priced for around two hikes, a narrower gap between the FOMC and the market compared to the last couple of years. In our view, market pricing looks about right, with our expectation centred on at least two rate hikes, with the balance of risk closer to three hikes than one hike. US monetary policy is currently out-of-sync with the rest of the world, with the Fed in the midst of a tightening cycle at a time when other major central banks are still operating quantitative easing policies. The ECB and BoJ are expected to be actively buying bonds all year as part of their asset purchase programmes albeit at slightly tapered rates compared to last year. The Bank of England s asset purchase programme is nearing its final stages. None of these three major central banks are expected to raise interest rates this year. Closer to home, a number of economists are predicting the RBA will cut rates this year including our colleagues at NAB. At this stage, market pricing of little change in the RBA s policy rate all year seems fair and it would take Page 2

3 some soft activity and inflation data to kick the RBA into gear. Expectations for RBNZ tightening in 2017 ramped up towards the end of last year and the market prices in a full 25bp hike by the end of this year. Market pricing is consistent with the Fed and RBNZ being two notable central banks tightening, going against the grain of other central banks. As the year begins we see this monetary policy dynamic as supportive for both the USD and NZD against JPY, EUR, GBP and AUD. We see the balance of risk being more, rather than less tightening being priced in for NZ and US monetary policy through the next months. However, as the year progresses this dynamic could easily change as the market turns its attention to 2018 and beyond, namely the end of QE in the euro area and Japan and possible future rate hikes by the ECB, BoE and RBA. NZ & US Rates Consistent With Policy Tightening Ahead Year Swap Rates With Forwards 1 Forwards 0 Other Currency Drivers NZ Australia US The current global environment is supportive of the NZD. Our risk appetite index is trading close to a 2-year high, global economic momentum is upward and global commodity prices are consolidating at levels much higher than a year ago. This should continue to provide near term support to the NZD. The NZD tends to be positively correlated with both risk appetite and global commodity prices. However, this positive backdrop is unlikely to be sustained all year. At some stage during the year risk appetite is likely to falter. An unwinding of current positive market sentiment conditions would ultimately negatively impact the NZD. It s a similar story for domestic drivers. The year begins with decent growth momentum but our economic projections are consistent with waning momentum as the year progresses capacity constraints being met, less supportive credit conditions, and weaker net migration are all possible sources of a weaker domestic growth dynamic. NZ s terms of trade are close to peaking, following the surge in dairy prices last year. We expect dairy prices to end 2017 somewhat lower than where they began. Higher oil prices are also a negative factor for NZ s terms of trade. These factors point to reduced NZD support during NZ Terms of Trade Close to a Peak NZ Terms of Trade Proj Finally, an outlook for the NZD wouldn t be complete without noting the long-standing risk factor in the form of China s currency outlook. The chart on the first page highlighted the strong link between NZD/USD and an Asian currency basket, itself influence by the path of the Chinese Yuan. China has ramped up its capital controls over recent months in order to reduce downward pressure on the Yuan via large scale capital outflows. The cost of this currency management policy has been a reduction of USD800m of foreign reserves over the past two years to just over USD3 trillion. This level is still comfortable on IMF methodology but the pressures are clear. China s government will want to keep a strong hand on the currency tiller ahead of the 19th National Congress of the Communist Party of China, due in Q3. This is the 5-yearly party congress which determines China s leadership over the following 5 years. With this leadership contest ahead, downside risk to the Yuan is arguably less than it was last year. That said, downside risk to the Yuan this year remains a negative factor for the NZD and other Asian currencies. Rather than China s battle with capital controls and outflows, the Trump factor is possibly the bigger risk this year regarding Asian currencies. Trump has so far tried to agitate China on its one-china policy. We see this as typical of Trump s unorthodox negotiating strategy. More pleasingly, Trump appears to have backed down on labelling China a currency manipulator on day one. Page 3

4 Summary Our core view is that, despite the current short-term retracement, the USD will generally remain well supported for much of the year. However, this is a strong consensus opinion, with the market positioned for a stronger USD. Speculative positioning data puts net long USD positions at their highest level in a year so there is some near-term vulnerability if expectations are not met. Forthcoming US data will need to show solid economic momentum, the Fed will have to deliver on at least two rate hikes this year, and more concrete evidence of fiscal stimulus ahead will be required for the USD to return to an upward trajectory. Modest Downside Risk to NZD Later This Year NZD/USD and NZ TWI 0.85 TWI (rhs) NZD/USD (lhs) Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan It is unlikely to be a smooth run, as is typical in markets, and that will provide some trading opportunities. Our near term bias is one where the USD could soften a little further, allowing the NZD to tickle up a couple of cents more, towards our short-term fair value estimate of USD0.74. With increasing headwinds for the NZD later in the year, our year-end target remains at USD0.67. jason.k.wong@bnz.co.nz Page 4

5 Contact Details BNZ Stephen Toplis Head of Research +(64 4) Craig Ebert Senior Economist +(64 4) Doug Steel Senior Economist +(64 4) Kymberly Martin Senior Market Strategist +(64 4) Jason Wong Currency Strategist +(64 4) Main Offices Wellington 60 Waterloo Quay Private Bag Wellington Mail Centre Lower Hutt 5045 Phone: +(64 4) FI: Auckland 80 Queen Street Private Bag Auckland 1142 Phone: +(64 9) Toll Free: Christchurch 81 Riccarton Road PO Box 1461 Christchurch 8022 Phone: +(64 3) Toll Free: National Australia Bank Peter Jolly Global Head of Research +(61 2) Alan Oster Group Chief Economist +(61 3) Ray Attrill Global Co-Head of FX Strategy +(61 2) Skye Masters Head of Interest Rate Strategy +(61 2) Wellington Foreign Exchange Fixed Income/Derivatives Sydney Foreign Exchange +(61 2) Fixed Income/Derivatives +(61 2) New York Foreign Exchange Fixed Income/Derivatives Hong Kong Foreign Exchange +(85 2) Fixed Income/Derivatives +(85 2) London Foreign Exchange +(44 20) Fixed Income/Derivatives +(44 20) ANALYST DISCLAIMER: The person or persons named as the author(s) of this report hereby certify that the views expressed in the research report accurately reflect their personal views about the subject securities and issuers and other subject matters discussed. No part of their compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in the research report. Research analysts responsible for this report receive compensation based upon, among other factors, the overall profitability of the Markets Division of National Australia Bank Limited, a member of the National Australia Bank Group ( NAB ). The views of the author(s) do not necessarily reflect the views of NAB and are subject to change without notice. NAB may receive fees for banking services provided to an issuer of securities mentioned in this report. NAB, its affiliates and their respective officers, and employees, including persons involved in the preparation or issuance of this report (subject to the policies of NAB), may also from time to time maintain a long or short position in, or purchase or sell a position in, hold or act as advisors, brokers or commercial bankers in relation to the securities (or related securities and financial instruments), of companies mentioned in this report. NAB or its affiliates may engage in these transactions in a manner that is inconsistent with or contrary to any recommendations made in this report. NEW ZEALAND DISCLAIMER: This publication has been provided for general information only. Although every effort has been made to ensure this publication is accurate the contents should not be relied upon or used as a basis for entering into any products described in this publication. Bank of strongly recommends readers seek independent legal/financial advice prior to acting in relation to any of the matters discussed in this publication. Neither Bank of nor any person involved in this publication accepts any liability for any loss or damage whatsoever may directly or indirectly result from any advice, opinion, information, representation or omission, whether negligent or otherwise, contained in this publication. US DISCLAIMER: If this document is distributed in the United States, such distribution is by nabsecurities, LLC. This document is not intended as an offer or solicitation for the purchase or sale of any securities, financial instrument or product or to provide financial services. It is not the intention of nabsecurities to create legal relations on the basis of information provided herein. National Australia Bank Limited is not a registered bank in. research.bnz.co.nz Page 5

Currency Research. NZD: Long term value emerging vs USD RESEARCH. 28 August bnz.co.nz/research Page 1

Currency Research. NZD: Long term value emerging vs USD RESEARCH. 28 August bnz.co.nz/research Page 1 RESEARCH Currency Research 28 August 2018 NZD: Long term value emerging vs USD Long-term fair value estimates can vary widely depending on the methodology used. A pure longterm (post NZD-float) purchasing