NZD/USD Outlook
After consolidating for most of the fourth quarter, the New Zealand dollar ended 2006 virtually unchanged after having fallen to an over two year low below 60 cents thanks to strong carry trade interest from macro funds and other large speculators. Still sporting the highest yielding interest rate of the major industrialized economies, plenty of bid interest continues to bolster the underlying currency, especially against low interest rate currencies like the Japanese yen.
The notion has been supported by continued promises of no rate reductions by central bankers as economic fundamentals keep Reserve Bank of New Zealand Governor Alan Bollard and his fellow policy makers on their toes. In particular, domestic retail spending and inflation rates are above the central bank’s comfort level which supports tighter monetary policy. However, what has kept the appreciating currency at bay has been further criticism from Finance Minister Cullen and the initially negative impacts of the strong currency on the economy.
Carry Trade Revival
With central banks, particularly in the US and New Zealand, keeping rates at their currently high levels, speculators have piled back into the carry trade throughout the fourth quarter. This will probably continue to remain true going into the first quarter of next year as Japan is in no rush to raise rates while the Reserve Bank of New Zealand has no near term plans for reducing rates from their current level of 7.25 percent. In fact, the market is even pricing in the possibility of another 25 basis point rate hike by the RBNZ in the first quarter of 2007. This sentiment stems from recent strength in consumer retail spending as well as a tight labor market. Subsequently, labor costs and wages have risen, boosting the amount of disposable income available to domestic consumers and increasing the rate of retail sales to 5.9 percent year on year. The momentum has boosted spending in the short term, with retail sales gaining for a healthy six consecutive months leading up to year end. Increases are not only being seen in the retail sector but also the housing sector, which recently reported that sales of residential homes jumped to an eight month high. According to the Real Estate Institute of New Zealand Inc, house sales rose 3.5 percent to 9,990 in November year on year. With housing prices higher by 10 percent, and consumer prices up by 3.5 percent on the year, there is plenty of justification for the RBNZ to continue to leave rates unchanged in the early part of next year.
Hawkish First Half, Dovish Second Half
However, even as the data purports a picture riddled with higher prices, there remains the likelihood that rate cut considerations will be on the horizon in the second half of the year. Even as retail sales figures climb, expansion overall is expected to decline comparatively. The lower forecasts of growth, and subsequent consumer price estimates, lend some credence to countering speculation that rates will be left alone at the 7.25 percent figure, with rate cut considerations potentially coming in the second half of 2007. The strength of the currency is beginning to hurt the economy. GDP grew by 0.3 percent in the third quarter, which was less than half of what the central bank had forecasted. Annualized growth dropped to 1.4 percent, the slowest in seven years. The gradual slowdown will take consumer prices lower in tandem in the $108 billion economy. Survey results indicate that factory managers expect a reduction in inflation to 2.7 percent in second half of the year due to a slowdown in export growth. The figure is a clear drop from the 15-year high and falls well below the 3 percent target set by central bankers. Additionally, with a trade deficit that equals close to 9 percent of overall GDP, the economy may be set for a soft landing, curbing the need for near term inflation protection. Don’t forget, the strong Kiwi is also helping to reduce inflationary pressures.
Commodity Boom Continues
The recent rebound in commodity prices have supported Kiwi bulls in the fourth quarter and are likely to remain a positive for the currency going into the first quarter of the New Year. Although pulling back for the second half of 2006, both gold and oil prices are expected to move higher off of near term support levels as they are set to retest previous highs. Fundamentally, there are plenty of reasons for higher commodity prices as emerging market economies will continue to add to increasing global demand as country’s like China and India continue to support their consumption rate of raw materials. Currently, India, China and the US constitute 50 percent of overall gold consumption, lending to an upside bias if two of the three countries increase consumption. Subsequently, oil prices are additionally set to make higher advances as OPEC considers production cuts in order to maintain a “fair” price in the market. We have already seen evidence of this through two announced cuts in the fourth quarter. With $50 a barrel predicted as the new bottom, higher prices of oil should add to the correlation that already exists against the Kiwi dollar, being a part of the Dollar Bloc.
Cullen Talk
However, keeping the gains capped in the near term, and weighing on the market even at the current moment are comments issued by Finance Minister Michael Cullen. Talking down the currency, Minister Cullen has been warning of an overvalued Kiwi dollar for some time now and continues to add to pressure by “clarifying” bullish statements by policy officials. Last quarter, the Finance Minister has gone so far as to warn speculators of a considerable drop in the underlying currency to as low as 40 cents since further monetary tightening is not assured at this point. The market of course has completely ignored him as they have since realized that even if he is concerned, the primary driver for the Kiwi right now is yield and Cullen has no hand in the future of direction of carry. Conclusion
With the current environment likely to remain carry friendly, upside potential in the New Zealand dollar looks promising in the short term. Offering the world 7.25 percent, the country still boasts one of the highest yields, which will add to the overall strength of the underlying currency. The longer the New Zealand dollar remains firm, the more improvements it brings to the inflation picture, but at the same time, the more strain it has on the overall economy. Therefore in all likelihood, we may see more see-saw price action in the NZD/USD in 2007, where we first have strength, then weakness should the RBNZ begin to talk about the possibility of lowering interest rates.
Technical Outlook
The Kiwi remains strong in the face of recent dollar strength. The rally stalled at the 61.8% of .7463-.5927 but this week’s close above (December 15th) gives scope to a test of the February 2004 high at .7098. Resistance is strengthened at this juncture by the 78.6% fibo of .7463-.5927 at .7132. The look since late 2003 is that of a large head and shoulders pattern. Of course, this pattern would not be completed unless the NZDUSD were to decline to below .5927. A steep trendline drawn off of the June and November lows is the bearish pivot. A decline below that line would begin to turn the medium term picture bearish and focus would then shift to the October low at .6486.