NZD Declines Only Temporarily, Says Westpac – More Gains on the Horizon

NZD Declines Only Temporarily, Says Westpac – More Gains on the Horizon

 Published: March 1st, 2023

February may have left Kiwi bulls feeling downcast as NZD suffered nearly a full month of declines, however better news is on the horizon. At least one major lender believes the New Zealand Dollar is headed for gains across much of this year.

In a report published this week, Westpac says 2023 will be a year of appreciation for the Kiwi and bank analysts are maintaining a positive stance on the fiat, pointing to factors such as the full re-opening of China's economy, rising commodity prices, and the welcome return of the tourist trade.

Having said that, NZD’s upside potential could be constrained by falling consumer confidence and spending power as housing prices in New Zealand are pegged to sink further, falling 20 per cent below the 2021 peak.

Westpac's research has landed after a period of weakness for the Kiwi that marks it as February's worst-performing G10 major.

‘A mix of macro and domestic factor have pulled NZD/USD back to around USD 0.61,’ says Westpac. Despite that, we believe this move will likely change course and that more resilient trends will take hold over the remainder of the year.’

NZD’s current retreat is likely down to its traditional positive correlation with wider risk appetite, meaning it tends to retreat when major global stock markets and indices decline.

Global equity prices suffered through much of February as investors turned wary after a rise in expectations for further interest rate hikes by the US Fed. AMerica's central bank has signaled that it may need to take action against inflation after a stronger-than-expected series of economic figures.

'American labour market data was robust in January, which led to a rise in risk-off sentiment in currency markets. In short, forex traders started buying the greenback again,’ added Westpac.

But the bank’s analysts say this will probably be a short-lived trend, with a return to higher NZD exchange rates soon.

‘We’re basing this view on the expectation that central banks around the world are slowly winning the battle against inflation and will continue to do so over the coming months. As this takes hold, riskier fiats like the New Zealand dollar will return to strength at the expense of safer options like USD.’

Aiding the Kiwi’s potential rise will be rising New Zealand exports and a series of hikes to interest rates by the Reserve Bank of New Zealand (RBNZ).

Westpac is looking for the RBNZ's cash rate to peak at 5.5 per cent by mid-year 2023, up from 4.75 per cent this week. That would bring the cash rate level with the Fed’s expected peak, but place it higher than the Eurozone’s, Australia’s or Japan’s.

That rate 'advantage' could add support.

Cows and commodities

At this time last year, the Kiwi was being buoyed by rising New Zealand dairy prices, boosting income from a key commodity export and alleviating some of the uncertainty brought on by inflation fears and the resurgent COVID Omicron variant.

'Given sub-optimal growing conditions and the failure of overseas producers to step in and displace NZ farmers, we believe the current market view is correct,' said New Zealand lender ASB's economics unit in an investor note. 'Supply is likely to stay tight beyond the end of the season.

Fonterra's Global Dairy Trade price index for New Zealand suggested milk prices had reached their highest levels since March 2013, giving a considerable fillip to New Zealand's export earnings prospects.

ASB believed tight supply would persist into the 2022/2023 growing season, pushing milk price forecasts to a healthy USD 8.90 per kgMS.

Dairy products are New Zealand’s biggest export category, bringing in around USD 12.6 BN annually. Dairy accounts for one in every three dollars the country earns from exports. Rising dairy prices will almost certainly lift New Zealand's trade dynamics, giving the kiwi (NZD) a fundamental source of support.

In a market commentary, the International Economics Unit at Commonwealth Bank of Australia said the rise in dairy prices also supported its NZD/USD forecast of 0.75 by year-end 2022.'

As of February 2020, New Zealand exported USD 13.8 BN in dairy products, injecting NZD 7.5 BN directly into the New Zealand economy.

Fonterra's price index said New Zealand dairy prices had reached a seven-year high at the end of January 2022, amid extended strong demand and reduced dairy production globally.

Fonterra is the Antipodean nation's largest dairy company, a co-operative owned by New Zealand dairy farmers that handles more than 90 per cent of all milk production. Its January auction beat analyst estimates by more than four per cent.

‘It looks as though New Zealand farmers will begin next season on the front foot,’ said ASB in its investor note. 'Since near-term dairy supply is set to be down globally, demand for New Zealand dairy is still looking strong.’

Stepping out of USD’s shadow

Despite supportive export dynamics, NZD had also been trending lower against the US dollar and UK Pound at this point in 2022.

Those trends suggested the kiwi was still beholden to uncertain global market conditions, despite New Zealand’s strong export fundamentals. The shaky start to 2022 exhibited by global equity markets played a role in NZD’s price action.

At the same point in 2022, forex traders had priced in expectations for a rate hike by the Reserve Bank of New Zealand (RBNZ), holding the fiat back from a lift caused by increasing speculation about the central bank taking the G10 lead in terms of tightening monetary policy.

Questions about how the economy would fare in the midst of the Omicron outbreak weighed on the NZD outlook for much of early 2022.

Speaking to Bloomberg, senior Westpac Economist Sam Chowdhury said that there was uncertainty about how Omicron would impact the labour market. ‘We are still in the early stages of this variant spread, and it's too soon to say how negative the health outcomes might be.’

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