Macro: Sandcastle economics
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Year in Review: The kiwi's surprising strength
John Hardy
Chief Macro Strategist
Summary: The surge in the trade-weighted New Zealand dollar over the last quarter of 2018 against a backdrop of weak risk appetite has been one of the most surprising developments among the smallest of the G10 currencies.
The New Zealand dollar finished 2017 on a weak note after the September national election resulted in a center-left and left populist government coalition that vowed to curtail foreign purchases of New Zealand real estate and limit immigration.
After stabilising early this year on the assumption that the government’s bark would prove worse than its bite the NZD, or kiwi, took a fresh dive as Adrian Orr was nominated Reserve Bank of New Zealand governor in March. Orr quickly established himself as a loud dove on policy, opening up forward guidance to the potential for both rate cuts as well as rate hikes in an environment in which most global central banks were clearly pointing toward the withdrawal of policy accommodation.
The trade-weighted kiwi bottomed out in early October before launching a near vertical ascent, even as global market. In past market cycles of weak global risk sentiment, the kiwi has fared rather poorly and we struggle to put together a narrative that explains the kiwi’s marked resilience and even strength into the end of this year.
JP Morgan NZD CPI-adjusted real effective exchange rate
After a long period of weakness for the reasons we mentioned above, the kiwi sprang to life from early October and crossed well back above its 40-week moving average. The period of NZD strength in from 2011 to 2014 flatters the currency, as the historic range stretches all the way down to 80 and even lower – suggesting that levels significantly above the 100 area are overvalued.
One potential source of relative strength may be the market’s increasingly pessimistic take on the outlook for Australia’s economy relative to the outlook for New Zealand and interest in selling AUDNZD.
Australia’s housing bubble showed signs of a disorderly unwind as 2018 was drawing to a close. The fall in Australia’s housing prices was at least partly triggered by tightening lending standards after a profound and embarrassing review of sharp bank practices under a Royal Commission.
New Zealand’s housing market has also been under pressure, but the focus there under the previous RBNZ governor on macroprudential rules to restrict over-easy lending standards into the sector has helped to prevented the excesses evident in Australia.
Chart: AUDNZD monthly
Australia is New Zealand’s largest trading partner after China and the AUDNZD rate has declined to the lower end of its multi-year range, with much of the recent part of the move arriving after the RBA admitted that rate cuts and QE are a theoretical possibility if the housing bubble unwind become dire, even while expressing confidence that the next move would be a hike.
If AUDNZD nears parity, it is approaching a rare extreme that historically has proven a bridge too far for NZD strength.
Regardless of the set of drivers, the New Zealand dollar looks very expensive going into 2019 and we suspect it will end next year far weaker than the levels prevailing here at the end of 2018 on value mean-reversion and the risks to global growth.
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