“Muddy water, let stand, becomes clear.”
Commentary & Analysis
The New Zealand dollar…Is it overvalued against the US dollar? I think so.
I’ve suspected for a while the NZ$, affectionately known as the Kiwi (with seems inappropriately named after a flight-less bird given how the currency has soared), has been overvalued against the US dollar. But suspecting that, and being correct, has nothing to do with trading it with success; my NZD/USD trade P&L, bleeding red for the most part, proves that.
But hope springs eternal.
Below is a chart from John Pecival’s Currency Bulletin [his source Deutsche Bank FX Research] which shows forecasted over/under valuation of some key currency pairs against the US dollar—notice Kiwi is 36.5% overvalued according to DB.
Does a currencies strength in the end all come back to the strength of the economy? For the most part the answer is yes, as economic strength (real vs. nominal considered) is a driver of interest rates, which determine relative yields for the local currency, which ultimately is the driver of both hot money and foreign direct investment . The major exception we have witness in our trading life-times is the Japanese yen, i.e. a strong currency for many years with a very weak economy. But sticking to the economic strength theme in determing value, it seems the New Zealand economy is facing some strong headwinds. Consider the fact three of the four top export destinations for Kiwi goods—Australia, China, and Japan— aren’t exactly zooming along.
And consider how far the currency has run against regional competitors Australia and Japan [the Chinese currency has appreciated against the Kiwi over the time frames shown below]:
NZD/AUD Daily: Kiwi has indeed soared against the Aussie…closing in on that big-round parity number…
NZD/JPY Daily: Ditto on the soar-factor relative to Japan…
So, when the chairman of New Zealand’s Reserve Bank says the Kiwi is “too high,” I believe him. His jawboning hasn’t done the trick, however. I think it is because yields in New Zealand are extremely attractive for hot money flow relative to elsewhere sitting at a whopping 3.2% on 2-year NZ Notes.
United States minus New Zealand 2-yr Benchmark Spread: This chart shows you can achieve a 2.687% yield advantage owning New Zealand 2-yr Notes instead of the United States benchmark paper…
So, despite the headwinds facing the NZ economy, a 2-yr yield towering over the other major pairs makes Kiwi a prime destination for carry trades. But what could change this dynamic?
- A rate cut by the Reserve Bank of New Zealand on the grounds its currency is “too high;” but
likely we may need to see some proof in the form of pressure on the current account—which has
in fact improved over the last two quarters:
- A sell-off in risk assets (read the stock market) could hit Kiwi as it did back in 2008…interesting
in that Kiwi still trades in-line with emerging market stocks…they are likely still running on the
similar dynamics of growth and US dollar trade funding…
…so, for better or worse short NZD/USD I am again on the technical setup below…
…and looking for something to click!