Not much love from Kiwi bulls this past year despite some positive risk-on vibes in the global market to finish off 2017. Why did the Kiwi break from the rest of “risk assets” and fall to the bears in the end?
Before reviewing, let’s first take a quick look at the New Zealand dollar’s price action against the other major currencies:
In the daily chart above of the New Zealand dollar versus the rest of the majors, it’s pretty easy to see the trend from upper left to bottom right. The only currency that the Kiwi managed to snag a gain from in 2017 was the U.S. dollar, which as you will see in our upcoming USD review, ended up as a loser against all of the majors this year.
So what happened? Well, let’s start from the beginning…
At the start of 2017, we saw the usual Kiwi tendencies of tracking commodities (New Zealand relies heavily on agriculture and farming) and global risk sentiment/bond yields. If you recall at the start of 2017, global risk sentiment (worries of Trump’s reform agenda, Brexit jitters, upcoming European elections, North Korea/U.S. tensions) was off to a shaky start with geopolitical fears putting a damper on traders’ urge to buy up risk assets. Comdolls also took a hit in late April when there was talk from Trump of import taxes on Canada that could be applied to other countries like New Zealand.
From January through May, we saw a very strong 83% correlation between the two indexes, but from June through the rest of the year that correlation completely flipped to an -88% correlation, suggesting that’s when investors and traders became bitter on the Kiwi. This is despite the positive global risk sentiment environment that lifted commodities, equity markets, and other higher-yielding currencies through the rest of the year.
So what happened? It’s impossible to cover all of the potential arguments that we could attribute this change in behavior to in one short piece, but in my opinion, it came down to two big factors: New Zealand’s export economy and changes in its government leadership.
Global Dairy Prices take a hit
For those who aren’t the know, New Zealand relies heavily on its export market with its goods and services making up around 30% of gross domestic product (GDP). And a big chunk of that economy comes from the farming and agriculture sector with New Zealand’s top exports coming in the form of concentrated milk, sheep and goat meat, butter, and wood.
With milk being New Zealand’s largest export, often times we’ll see volatility in the Kiwi dollar pick up and traders’ bias dominated by changes in the Global Dairy Trade Price Index. And in 2017, it looks like the market became sour on milk:
In the chart above between the New Zealand dollar TWI versus the percent price change at each global dairy auction, dairy prices reached peak rate of appreciation (3.6%) at the beginning of May. This is likely where the correlation between the Kiwi and the rest of the market started breaking as the positive GDT price and Fonterra’s upgraded milk forecast lifted the Kiwi despite global risk-off vibes and weak commodity price action at the time.
But by the middle of June, dairy prices were stepping back and with exception to one or two positive auctions, milk price declines accelerated to almost -4% in November and December. The likely causes for this decline may be attributed to strong production and inventories in Europe (suppressing prices globally), as well as dry weather in New Zealand curbing production.
Going back to the chart of NZ TWI vs. GDT price changes above, we can see a strong correlation between the dairy auctions and the Kiwi’s trade weighted price; more often times than not the value of the Kiwi would drop for several days after a negative dairy price auction and vice versa.
Overall, there’s more to New Zealand’s economy thank milk prices, but it definitely looks like traders took almost every auction result as a cue on which direction to go with on the Kiwi.
New Zealand Changes Government
The other big factor I’ll say likely had a strong influence on the Kiwi’s decline is the change in government leadership.
In September through October, we saw political drama create uncertainty for the New Zealand dollar with general elections for parliamentary seats, mainly between the National Party and the Labour Party. Government elections tend to bring uncertainty and less risk taking as the country’s outlook on future policy and governance is temporarily clouded during this time.
And with New Zealand’s general elections, this clouded outlook was extended as a majority government wasn’t established right away. The National Party won most of the seats, initially at 58, but wasn’t able to secure the necessary 61 seats for majority. And to make the uncertainty for Kiwi worse, the New Zealand First (NZF) Party snagged 9 seats, giving them the power to form a coalition government with either the National or Labour and putting New Zealand in political limbo until they chose a side.
After much negotiation and drama, the NZF decided to back the Labour Party in late October, sparking further Kiwi bearishness as this new government would likely adopt protectionist policies (not foreign investor or immigration friendly), and there was strong talk of overhauling the Reserve Bank of New Zealand. In the past, Labour has been known to want to add employment targets and other changes to the RBNZ’s mandate like the Federal Reserve. This sparked concerns that the RBNZ’s projected 2019 rate hike would be pushed back, another bearish development for the Kiwi.
Finally, New Zealand got a new Prime Minister in Jacinda Ardern, who is also a proponent for less foreign ownership, changes to RBNZ’s mandate to inflation and unemployment rates, and a big opponent of high immigration levels. These future value guidelines for New Zealand looked to be solidified with her late October speech when she selected Winston Peters of the NZF as Deputy PM, sparking another push lower in the Kiwi dollar to near its weakest levels of the year.
What’s Next for Kiwi in 2018?
I didn’t get a chance to touch on economic drivers and monetary policy in this write-up as they weren’t very strong medium-to-long term drivers of price this year, but here are a few charts that I think will give us enough to form a top level picture view for 2018:
GDP continued its string of positive growth, albeit at lower levels in 2017. The trade balance skewed towards negative as imports increasingly soared beyond exports as the year went on.
Positive signs of employment with a growth in the labor participation to five year highs and a further decline in the unemployment rate to near pre-2008 Great Recession levels.
The inflation growth rate was positive in 2017 and above recent years , but often times below expectations.
Overall, we’re seeing some positive signs from the latest economic data, but with a new government looking to be more protectionist and to overhaul the central bank, I’m skeptical of a Kiwi rebound in 2018. A strong dairy market could be a lifting factor, but the outlook of milk conditions are lower in Fonterra’s latest forecast for the 2017/2018 season. And while I think this is a low probability situation, I think the data is good enough where the RBNZ could potentially up their rate hike rhetoric (not hike rates) in the next year if current economic conditions hold or improve.
Right now, though, the Kiwi’s downtrend might be the way to go to start 2018, but with the NZ general election drama out of the way, the Kiwi could revert back to tracking global risk sentiment, bond yields, and commodities until major government and/or central bank changes are under way. So, it’s probably a good idea to keep up with the news by following Pip Diddy’s daily session updates!
What do you think is next for the New Zealand dollar in 2018? Share your thoughts and analysis in the comments below!