Published: October 19th, 2022
A downbeat forecast by London analysts Capital Economics suggests AUD and NZD are headed for further losses as sinking global stock markets and tepid commodity prices prove unsupportive into 2023.
In a note to investors published this week, the firm said that while the Australian and New Zealand Dollars have already dipped below its negative year-end forecasts, ‘we now believe both will fall further in the face of 2023 headwinds.’
For most of 2022 the Aussie has been one of the better performing majors, having only been surpassed by the Greenback (-13 per cent), the Canadian Dollar (-5.4 per cent) and the Franc (-5.2 per cent).
But looking at the previous 30-day and 7-day timescales, AUD has become the worst performer of the lot, suggesting a build-up of near-term weakness.
The New Zealand Dollar has also been a strong performer for much of 2022, pushed upward along with other commodity currencies when Russia's invasion of Ukraine sent commodity prices surging.
Unlike its antipodean neighbour, however, the Kiwi has been an underperfomer in recent weeks.
‘Unlike what we saw earlier this year, we don’t believe commodity prices will be enough to support AUD and NZD into 2023’.
Capital Economics believes commodity prices could actually move against the two currencies, partly due to the sensitivity of prices for their major exports to demand from China. Capital says the near-term economic outlook in China ‘currently looks bleak’.
The global economic backdrop also appears to be unsupportive for risk-sensitive currencies like AUD and NZD.
‘External factors for both economies will remain unfavorable given that the global economy has likely slipped into recession. Central banks are tightening monetary policy in hawkish mode while demand continues to lose steam.’
Investor risk sentiment has been cooling for most of 2022, and Capital analysts believe it will stay that way for some time, with rising Fed interest rates blamed for much of the anticipated underperformance.
While the US Fed is rapidly raising interest rates, the central banks of Australia and New Zealand are expected to hold back the pace of rises. Capital believes investors are discounting a tight monetary policy stance from both the Reserve Bank of Australia (RBA) and the Reserve Bank of New Zealand (RBNZ).
Property markets in both countries are at risk of a steep slowdown in the coming months as higher interest rates make mortgages less affordable.
When fragile housing markets dominate, central banks risk creating new crises if they raise interst rates too quickly.
‘We're watching for a sharp downturn in the Australian and New Zealand housing markets, which could add to wider economic weakness and prompt the RBA and RBNZ to cut interest rates next year’.
One of the dominant forex market drivers this year has been the pace of central bank policy normalisation, with analysts and traders watching closely to see how quickly monetary policymakers would raise interest rates and scale down pandemic-driven quantitative easing.
Analysts at Morgan Stanley said back in January that the Reserve Bank of New Zealand (RBNZ) was likely to disappoint on interest rates, despite the high expectations held by investors.
The bank’s Forex Analysis unit said the New Zealand dollar (NZD) looked potentially overpriced and at risk of a correction as RBNZ rate hike expectations move to the downside. The key determinant will be the impact of the Omicron COVID-19 variant on central banker opinion.
In a note to investors, Morgan said central banks around the world were considering changing economic and trade dynamics thanks to the COVID-19 pandemic’s most recent surge. As caseloads rose, demand was expected to be affected by curbs on economic activity and travel.
Markets continued to price in hawkish action by the RNBZ regardless, Morgan said, despite higher infection rates. ‘If the bank delivers a surprise on the dovish side, there's more potential for NZD weakness than if they deliver as anticipated on the policy front.’
The note came at a crucial point, given that four of the world's biggest central banks might be poised to raise rates again in the first quarter. For the Reserve Bank of New Zealand, it was the third rate hike in six months.
When it eventually arrived, the yields on government bonds spiked, followed by a concurrent rise in the cost of consumer and business borrowing. Countries that took the lead in raising rates did see their currencies advance, but they also risked disappointing currency markets if the magic bullet of a rate hike didn’t lead to extended gains.
For much of 2021, NZD was the G10’s second-best performer, with only the Norwegian Krone offering occasional competition.
In August 2021, USD/NZD reached the seventh day of successive declines, while NZD/GBP rose from an August low of 0.6802 back to levels above 0.7046.
The price dipped again when the RBNZ made the surprise decision to ignore market expectations and let interest rates stay at low levels. Bank policymakers said the recent imposition of new COVID-19 lockdowns was behind the decision. No change to the country’s economic fundamentals had been identified.
When expectations grow for higher interest rates, exchange rates for the New Zealand dollar tend to respond quickly.
At the time, the RBNZ’s policy committee seemed keen to sustain market expectations for higher rates. The bank’s assistant governor, Christian Hawkesby, had told the financial press that the central bank was fully committed to higher rates. Forex traders responded by opening new positions or holding NZD.
Hawkesby said in an interview with Bloomberg that the bank ‘could have easily supported a hike,' but given that the government was set to announce new lockdowns the same week, the bank believed the timing for a rate change was wrong.