New Zealand Dollar Runs Out of Steam as Interest Rate Cuts Beckon
Currencies / Forex Trading Jul 14, 2008 - 04:28 AMBy: Money_and_Markets
Jack Crooks writes: Last week I told you the U.K. could see a worse economic downturn than the U.S., and said that would weigh heavily on the British currency.
Meanwhile, one of my readers who resides Down Under recently told me that he's afraid to trade the Australian dollar.
Reason: He sees the economy first hand, and he's starting to see a disconnect between on-the-ground conditions and the Aussie dollar's rocket-ride to multi-decade highs.
Clearly, the risks aren't just limited to the United States ... at least not anymore. And today I want to tell you about another currency that looks ripe for weakness ...
New Zealand: From Fairy Tale to Tail Spin
Known primarily for its agricultural activity and natural resources, New Zealand has been quietly living the good life. After all, the commodity-price bullet train has boosted prices for all kinds of foods, metals and energy products.
Meanwhile, the central bank's benchmark interest rate made investing in New Zealand rather attractive.
End result: Over the last several years, the New Zealand dollar has appreciated quite notably versus the greenback. You can see its steady climb higher in the following chart ...
But this trend could be set to change. Here's why ...
First of all, Allen Bollard, one of the Reserve Bank of New Zealand's (RBNZ) governors, recently expressed the need for rate cuts. He cited the softening New Zealand economy, and I can see why. Here are five signs that stick out like sore thumbs:
- New Zealand's first-quarter GDP contracted for the first time since 2005.
- Export volumes slumped 3.5% in the same period.
- For the month of May, home sales fell to their lowest levels in 16 years.
- Retail sales in the first quarter fell at the fastest pace in 11 years.
- And the labor market is showing signs of rolling over — unemployment jumped 0.2% in the first quarter.
And it's not just Mr. Bollard who feels iffy. An RBNZ survey revealed similar concerns among business managers, who said they expected:
- Inflation rising each of the next two years.
- GDP growth contracting over the next year.
- Unemployment increasing over the next two years.
- And most importantly, monetary conditions beginning to ease at the start of 2009 .
I say "most importantly" because the state of monetary policy has been a big driver of New Zealand dollar strength. And the way things are going, it's set to be a big driver of New Zealand dollar weakness over the coming months.
Interest Rates Giveth, And Interest Rates Taketh Away
Think about it this way: The benchmark interest rate of the Reserve Bank of New Zealand sits at 8.25%.
That's comfortably higher than the Reserve Bank of Australia (7.25%), the Bank of England (5%) and the European Central Bank (4.25%).
And it's considerably higher than the Bank of Canada (3%), the Swiss National Bank (2.75%), the U.S. Federal Reserve (2%) and the Bank of Japan (0.5%).
Simply put: The RBNZ interest rate has garnered quite a bit of New Zealand dollar investment.
But now two things are happening that could quickly reverse this appeal.
First, interest rates at the RBNZ need to come down. If they don't, policy makers risk choking off New Zealand's economy to an even greater extent. I mentioned the main points of weakness already. It's clear that top ranking officials, as well as the businessmen elbow-deep in the economy, agree that New Zealand is headed towards recession should conditions not improve dramatically.
When rates start coming down on a relative basis, then capital begins fleeing.
Second, risk-takers can't take it no more . Even if central bankers start cutting the RBNZ interest rate, they've got quite a ways to go before they reach the level of most other major central banks' rates. That could mean the New Zealand dollar maintains a bit of interest rate appeal. But the thing is, even more money will flee if risk aversion takes hold of the markets.
When investors are comfortable taking risks, borrowed money typically flows into high-yielding investments. The New Zealand dollar, at 8.25%, is one such high-yielding asset. But when investors become fearful, they begin running for the exits.
And right now, the stock markets — a major place for risk taking — are telling me that a flight to safety could happen suddenly. Stocks, particularly in the U.S., are looking nasty. So nasty that the S&P 500, the Dow Industrials and the Nasdaq have recently been officially declared to be in "bear markets."
If and when risk-takers give in to their fears, money that's been stashed away in New Zealand dollar assets could quickly be yanked away. The result — notable depreciation in the New Zealand dollar.
One last thing to keep in mind is how this would play into the U.S. dollar story ...
As much as I would like to tell you the U.S. economy is making notable improvements, I can't yet do that. And thus, I can't use that as a reason for a rebound in the greenback.
However, as other major economies begin to break down, their currencies will eventually follow. And that means the U.S. dollar, as far as currency traders view it, becomes relatively less toxic.
Look, major changes are in the works. Before we know it, the dollar could be emerging from despondency as other currencies slip into it.
Best wishes,
Jack
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