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Currencies AUD 2014 – A Bright Year for New Zealand Dollar

By Kathy Lien

2013 has been a great year for the New Zealand dollar and for 2014 the outlook is even brighter. The value of the kiwi did not change much in U.S. dollar or British pound terms this past year but against the Australian dollar and Japanese Yen, the currency appreciated over 13%. There was also complete divergence between the performance of the AUD and NZD which drove the AUD/NZD cross to its weakest level in 5 years. Of all the major economies New Zealand offers the highest interest rate and with global growth expected to improve in the coming year, investors will be particularly attracted to high beta currencies and especially the ones who are poised for stronger growth and higher interest rates. The Reserve Bank of New Zealand will be the only major central bank raising interest rates in next year and this unique position makes the New Zealand dollar one of our favorite trades for 2014. The currency already saw quite a bit of gains in 2013 but stronger growth combined with a high and rising interest rate means there is scope for a broader rally.

3 Reasons Why We Like the New Zealand Dollar

There are 3 central reasons why we like the New Zealand Dollar:

1. Faster Growth
2. Rate Hike
3. Demand for Soft vs. Hard Commodities

Faster Growth – The resilience of New Zealand’s economy this year was nothing short of impressive. The country survived a slowdown in its 2 most important trading partners – Australia and China, fiscal consolidation, the worst drought in decades, a milk contamination scare and a strong currency. Each of these factors posed a significant risk to growth but these challenges were overcome easily with the latest GDP report for the third quarter showing the economy expanding at its fastest pace since 2009. The growth in New Zealand has been driven primarily by recovery. In Q3, farm output surged on drought recovery and throughout the year, the country also benefitted from rebuilding following the 2011 Christchurch earthquake. It is important to remember that New Zealand is a very small economy and major infrastructure projects can have a significant impact on growth. For the year ending March 31, 2014, the country is expected to grow at an annualized pace of 2.7% and according to the Treasury’s Half Year Economic Update, this growth is expected to rise to 3.6% in the year to March 2015. Additional work on the city center, major projects such as a convention center and stadium along with the development of precincts dedicated to health, technology and culture will contribute to growth. The recovery is also broadening beyond construction and housing. Residential and business investment along with growing demand for New Zealand’s exports should bring more jobs, higher wages, optimism and wealth.

Rate Hike - Above trend growth and a stubbornly strong housing market has the RBNZ worried about inflation. As recently as their December monetary policy meeting, the central bank said they would need to raise rates in 2014 to keep inflation near their 2% target. At a record low of 2.5%, New Zealand’s interest rate is more generous than any other major economy and in the coming year, the RBNZ will make buying the currency even more attractive and selling it more expensive. Aside from being the first developed nation to raise interest rates after the financial crisis, the RBNZ said they expect to lift rates to 4.75% (or 225bp) in 2.25 years time. The central bank tried to cool the housing market and in turn the economy earlier this year by tightening Loan to Value restrictions and while house sales slowed, house prices remain extremely high. The first rate hike from the RBNZ is expected in March and the prospect of tightening should fuel additional gains in the New Zealand dollar.

Demand for Soft vs. Hard Commodities - The main reason why the outlook for New Zealand and Australia differ is because New Zealand produces a commodity that will see increased demand from China’s focus on domestic growth. Approximately 90% of New Zealand’s milk powder is sold to China and as the middle class in China and India grow, their demand for milk and protein will increase. This poses both an opportunity and risk for New Zealand. While China’s appetite for foreign milk soared in recent years, contamination scares could shake the confidence of milk buyers in China who have already grown skeptical of their overreliance on Fonterra who has a major grip on the infant milk market in China. Nonetheless with the government relaxing its one child policy for its more than 1 billion population, there’s still plenty of demand to go around as long as they avoid a damaging reputational shock. While dairy and milk account for more than 35% of New Zealand’s exports, Iron Ore and Coal account for more than 35% of Australia’s exports. Unfortunately the development slowdown in China will hit the Australian economy hard in ways that do not affect New Zealand, which is why we believe AUD/NZD could drop to 1.05 and maybe even parity. Of course, Australia is still the country’s second most important trade partner and for this reason, New Zealand will not be immune to slower growth in Australia. However barring a severe slowdown, any decline in demand would be offset by stronger global growth and a rising middle class in the world’s most populated countries.

Won’t a Strong NZD Put the Brakes on Growth?

One of the biggest concerns that forex traders have is whether the strong and rising currency will put the brakes on New Zealand growth. At the last monetary policy meeting, the central bank said the exchange rate is not sustainable at its currently levels and they hoped that Fed tapering would lower the value of NZD/USD. However Central Bank Governor Wheeler stopped short of saying that the strong currency would discourage them from raising interest rates next year. The reason why the strong NZD is not a major concern at this time is because farming incomes have increased alongside the currency. Rising commodity prices have made the Kiwis wealthier and the greater purchasing power is boosting consumption, providing support for growth. Therefore we don’t expect the RBNZ to intervene in the New Zealand dollar unless the currency jumps 10% against the AUD.

New Zealand has a general election next year and John Key, the popular down to earth former foreign exchange trader is widely expected to win a third term as Prime Minister.

New Zealand Dollar – Potential to be 2014 Best Performer

• EUR/NZD – Looking for a move to 1.60 (Currently 1.69)
• GBP/NZD – 1.90 Target for GBP/NZD (Currently 2.02)
• NZD/USD – Bottom at 80 Cents, 80/85 Range
• AUD/NZD – Sell-off Could Stall at 1.05
The New Zealand dollar has the potential to be one of the best performing currencies next year. While the combination of Fed tapering and RBNZ tightening could limit the rise in NZD/USD, we believe there’s scope for stronger gains versus the AUD, GBP and EUR. We expect NZD/USD to bottom around 80 cents in the beginning of the year and then range trade between 80 and 85 cents in the coming year with a move towards the upper end of this band around mid February / March. After having fallen aggressively in 2013, the sell-off in AUD/NZD could be limited to 1.05 and there’s a high probability that the currency pair will drop to that level. Parity is possible especially if the RBA eases around the same time that the RBNZ tightens. We expect the biggest gains for NZD to be against the EUR and GBP. 1.60 is possible for EUR/NZD while a move to 1.90 for GBP/NZD is likely.

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