China's pivot away from investment-driven growth will be good for currencies of countries that export consumption goods to the world's second largest economy.
The New Zealand Dollar is the cheapest G10 currency in the bucket, according to strategists at Swiss investment bank UBS, and could benefit from the monumental shift in the makeup of the Chinese economy that is currently underway.
New Zealand’s Dollar has fallen by mid-high single digits against many of its global peers during 2017, given multiple factors, but UBS strategists say in their 2018 trade book that it could be worth a punt during the year ahead.
It has dropped close to 10% against Sterling and more than 6% against the Aussie in 2017. The last three months have seen it fall by close to 6% against the US Dollar.
“The recent election is in part responsible for this, but we think over time macro outcomes are more likely to drive NZD than politics, and the sell-off represents an opportunity to get long NZD,” say Yianos Kontopoulos and the UBS macro strategy team.
Many strategists have noted in recent weeks how the Kiwi currency could be due a rebound over the coming months, given the severity of the post-election sell off, but UBS strategists say the bulk of the currency’s gains is likely to come from elsewhere over 2018 and beyond.
“As the Chinese economy continues its rebalancing away from investment-led growth and toward increased consumption, the country’s import patterns will change with obvious knock on effects for its key trading partners,” says Kontopoulos.
The UBS team forecasts a tough time ahead for countries that have made their names through exports of investment goods (like metal raw materials) to China, given its shift away from the infrastructure investment growth of the past.
While not good news for the likes of Australia, which has done well from exporting iron ore to China, the Chinese pivot to consumption over investment will be good for economies that export consumption goods to China.
“New Zealand is a clear beneficiary, given the importance of agricultural products (milk and meat) to its economy and exports. New Zealand exports virtually no investment goods to China, so there no offsetting loss from a deterioration in these exports,” says Kontopoulos.
Taiwan is another such country that has historically exported only investment goods to China and so the “rebalancing” of China’s economy will be headwind to the country. The UBS team say buying the New Zealand Dollar over the New Taiwan Dollar is one way to profit from this shift in the short term.
“It is fair to argue that such slow-moving dynamics are difficult to trade. However, there are indications the shift toward consumption is impacting assets on a high frequency basis,” says Kontopoulos.
The UBS team calculated the sensitivity (beta) of major emerging and developed market currencies to positive and negative surprises reading of Chinese economic data such as retail sales and industrial production numbers.
They separated the two sets of data into two separate buckets, one of which relates to before 2013 and the other, the period after, due to changes in volatility of the data in recent years.
“We then calculated each currency's beta to positive and negative surprises within each regime, and looked for currencies that showed positive skew to the lower volatility regime,” says Kontopoulos.
The New Zealand Dollar comes in at number four on the list of currencies when they are rank ordered, with a “significant positive skew” to positive surprises in the economic data, while the New Taiwan Dollar has almost the highest negative skew.
“Finally, we note the entry level on long NZD positions is attractive on our short-term error correction model, where it screens as the cheapest G10 currency,” says Kontopoulos.
That said, it isn’t just the Taiwan Dollar that is likely to succumb to New Zealand Dollar strength during the coming quarters, as the UBS team are still flagging potential upside for the NZD/USD pair.
The bank’s forecasts have the Kiwi currency rising to 0.76 cents by the end of 2018, up from the 0.6842 cents level seen Monday, implying upside of around 10% for the year ahead.
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