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Drooping Milk Prices Drive NZD/USD Lower Ahead of RBNZ

Drooping Milk Prices Drive NZD/USD Lower Ahead of RBNZ

2015-10-23 20:56:00
James Stanley, Currency Strategist
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Drooping Milk Prices Drive NZD/USD Lower Ahead of RBNZDrooping Milk Prices Drive NZD/USD Lower Ahead of RBNZ

Fundamental Forecast for the Kiwi:Neutral

It was one of those good news/bad news weeks for the New Zealand economy. First, let’s get to the good news: It looks like Europe may increase their QE program at their December meeting, and China has stepped up the stimulus-front by adding in a surprise interest rate and RRR-cut after Asian markets had closed ahead of the weekend. This should largely be a boon for commodity currencies, especially those who export significantly to China; and for the New Zealand economy, this could add significant strength down-the-road, as commodity currencies (and commodities in general) have come under significant fire with the economic slowdown currently enveloping Asia. Should China finally be able to turn the corner, helped in-part by this most recent rate/triple-r cut, this could be a huge positive for the New Zealand economy.

Now on to the bad news: Milk prices, which are a key driver for the New Zealand economy, have been a steady and consistent down-trend with a ten+ year low being set earlier in August. This, of course, was at least partially-driven by the slowdown in demand from China, as New Zealand is a heavy exporter of powdered dry milk into the economy. But after that low was set at the August 4th auction, prices began running higher and we saw four consecutive auctions (with each auction taking place every other week) of higher prices; leading to the hope that China was turning the corner and that milk prices would continue their ascent.

But this did not come to pass; at least not at the most recent auction, where we saw lower prices for the first time since early August. This kicked the Kiwi down against most major currencies as the fear of a continuation in the down-trend (in both milk prices and NZD/USD) was enough to bring new sellers into the market. This brought the Kiwi-Dollar to a familiar level of support at the .6700 handle where it stayed for most of Wednesday ahead of the major ECB meeting on Thursday. And at that meeting, Mr. Mario Draghi added fuel to risk-on rallies as he mentioned that the European Central Bank would ‘re-examine’ their QE-outlay at their next meeting in December, and the New Zealand Dollar shot higher along with most other commodity currencies.

Moving forward, direction in the Kiwi will likely be determined by three primary factors: 1) The continued slowdown in China and whether or not the economy ‘turns the corner.’ 2) The continued softening of milk prices in response to #1. And 3) The RBNZ’s take on points #1 and #2.

We’ll hear from the RBNZ on Wednesday, and they’ve already made multiple indications that they’re expecting to ease policy further down-the-road; but we’re not expecting a cut at this meeting to the bank’s 2.75% deposit rate: Given the continued strength in New Zealand real estate, and the potential pressures of #1 and #2 above, its rational to expect that the RBNZ would want to ‘keep some powder dry’ (pun intended) in the event of a further slowdown. What we may see is a dovish tone from the RBNZ with a hat tip towards future rate meetings, particularly the December meeting as this would allow the bank another month’s worth of data to incorporate into their decision.

For now, the fundamental forecast in NZD/USD is neutral; and this could change to bearish with an overly-dovish tone from the RBNZ or another big move down in Chinese/Asian markets. To flip to a bullish point-of-view, we’d want to see some hawish commentary from the RBNZ combined with continued stability in Asian and Chinese markets.

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