A Bet Against the Kiwi

If one believes in the theory of purchasing power parity, then we should sell the New Zealand dollar with a view to realizing gains in Q3 2013. The NZD is significantly overvalued compared with its economic fundamentals, as was confirmed by the New Zealand Central Bank Governor Graeme Wheeler last week. Having surged since the beginning of 2013 due to reports of a healthy New Zealand economy and a change in its trade balance from a deficit of around NZ$500million to a surplus of NZ$500million, the NZD is at a potential cross-roads. With the NZD trading at 0.8397 to the USD at last sight, several factors suggest that it is time to sell the Kiwi with a view to realizing gains in Q3 2013.

1.The rising value of the NZD has made New Zealand’s exports less competitive, which should prove unhelpful for the NZD. Expect New Zealand’s terms of trade to deteriorate in the coming months.

2. US, EU and Japanese central banks have effectively printed money, lowering their exchange rates in a bid to stimulate their economies through an increase in exports. This has resulted in a surge in the NZD so far this year. The announcement that the US Federal Reserve is uncertain about continuing its unlimited quantitative easing program slightly decreased the NZD. However the impending statement from US Federal Reserve Chairman Ben Bernanke will offer greater clarity as to the strength of the division in the Fed Committee concerning the scale of quantitative easing that was highlighted in the FOMC minutes released last week. This will have a knock-on effect on global currencies due to the risk-on risk-off effect, with an ambiguous statement from Bernanke increasing the strength of the USD and being counterproductive to the NZD.

3. Strength in the AUD supported by demand among sovereign wealth funds for its bonds as well as continued FDI flow into the Australian mining industry will draw funds away from the NZD into the ‘hotter’ AUD.

4. This week sees the result of the Italian election, which may not be a clear-cut result and therefore would dampen the outlook for EU recovery and result in a retreat to haven currencies such as the USD and away from risk-appetite linked currencies such as the NZD.

5. NZD has advanced against the Yen as reports suggest that Asian Development Bank chief Haruhiko Kuroda is Prime Minister Shinzo Abe’s preference to be Governor of the Bank of Japan as he shares his desire to stimulate the economy through weakening the JPY.

6. There is a substantial amount of speculative longs in the NZD/USD, which confronted with this week’s event risk, may result in a sharp sell-off of NZD vis-à-vis other currencies.

7. NZ Central Bank Governor Wheeler has provided clarity on the conditions where the Central Bank would intervene to artificially bring down the NZD. His criteria for intervention stated last week were:

1. Is the exchange rate at an exceptional level?

2. Is this exceptional level justified?

3. Would intervention be consistent with the current monetary policy?

4. Is intervention likely to succeed?

Markets reacted to news that the Central Bank was not considering intervening by selling the NZD in the immediate aftermath of his statement. This is a signal that markets feel the NZD is currently overvalued, but a fix will have to wait for stimulus from market forces.

However, New Zealand’s size and limited funds confers special constraints on its ability to quickly influence its currency. Other developed countries with significant size can cut interest rates or directly intervene in its currency markets. New Zealand’s only options are longer-term, which is not necessarily a bad thing. Traders should look out for New Zealand government action to improve productivity, reduce foreign borrowing, cut fiscal imbalances as currently NZ Government’s future expenditures do not match their future revenue streams, and clarify distortions in their citizen’s saving and investment incentives. If such action is forthcoming, a long term view on the NZD’s depreciation would be favourable.