New Zealand Dollar Forecast to Recover in 2018: Citi

new zealand dollar exchange rates 8

Fears that a new government will enact policies which will harm the New Zealand Dollar are over exaggerated and the currency is due a recovery in the year ahead say analysts at Citi.

The New Zealand Dollar is forecast to make a comeback in 2018 by analysts at Citibank as the politically-inspired jitters of 2017 are shrugged off.

The currency has weakened notably over recent months with fears of, and then confirmation on, the election of a Labour-lead government in September. The New Zealand Dollar has shed 11% of its value against the Euro, 8.5% against the Pound and half a percent down against the Dollar in 2017.

The weakness has been inspired by what has been perceived to be a radical policy mix engendered by the new administration with areas such as trade, foreign ownership, immigration, and central bank policy set for change.

Most of the policies are seen as potentially negative for the Kiwi but Citi, who are the largest FX dealers in the world, take the view that the market is being unduly pessimisitc about the probable outcome.

So far the government has only enacted one major Kiwi-negative policy, which is the prevention of foreign ownership of newly built properties, however, because it does not apply to existing properties the actual impact has been minimal.

In many ways, Citi see this as a template informing how the rest of the governments policies could be rolled out, and indicates that may have sounded radical in the manifesto, may not be so in reality.

"Politically motivated underperformance from NZD is likely to unwind in 2018 as investor expectations on the extent of policy shifts under the Labour government moderate," says Citi.

Citi forecast more risk to NZD in the medium-term, however, as some of the policies, especially the heavy cap on immigration, reduce growth, however, going by experience so far, these may be more moderate in actuality.

"Pronounced changes to government policy on immigration and inward investment pose a greater medium-term threat, but moves thus far have been far more measured than anticipated," says the bank.

The Extent of Political Risk

It is possible to estimate the extent of the current negative impact of political fears on the exchange rate by comparing the AUD/NZD exchange rate to a common valuation method: if the two diverge greately then there is another influence at work. 

One common valuation method is the difference between interest rates in Australian and New Zealand as reflected in Australian and New Zealand government bond yields.

Usually, the greatest determinant of the exchange rate is the difference between the interest rates in two countries because investors tend to move money to where interest rates are higher to capitalize on the higher returns on offer, and these flows support currency demand.

The chart below shows the AUD/NZD exchange rate is substantially above the yield differential; usually they would be expected to be closer together.

This indicates another influence is at work making AUD stronger than NZD.

This X-factor is almost certainly political in nature and Citi have labeled it the 'Ardern effect', which is taken from the name of the new Prime Minister and leader of the Labour party Jacinta Ardern.

Spending and RBNZ Reforms

One potentially Kiwi-positive policy of the new government is a pledge to increase public spending which could help offset the stall in growth from lower immigration.

Citi dismisses the potentially negative impact on the Kiwi of promised reforms to the Reserve Bank of New Zealand (RBNZ), saying that they still fall in line with current international norms.

The new policies include the added mandate of the RBNZ encouraging 'full employment' alongside the existing pledge to maintain price stability, and the use of a committee to determine decisions rather than solely the Governor, as is currently the case.

Citi expect the Kiwi to outperform both the Aussie and Canadian Dollar, coming first out of the commodity block pack. 

Contrasting View From Westpac

Interstingly, Citi's views on the Kiwi - and other commodity currencies - are almost completely diametrically opposed to those of Westpac bank, for whome the Kiwi is still the untouchable of the three, whislt the Canadian Dollar they hold in high esteem.

Westpac are currently betting against the Kiwi with 33% of their portfolio - the most they are currently betting on a single currency in their portfolio of G10 currencies, which has averaged 6.6% return over the last 10 years.

They view the prospects of the Canadian Dollar as much better than those of the Kiwi.

"Canada's rising interest rates, better growth prospects and rising crude oil prices, are the main reasons for Westpac's preference for the currency," say Westpac. For further details read our report on the matter here.

Get up to 5% more foreign exchange by using a specialist provider by getting closer to the real market rate and avoid the gaping spreads charged by your bank for international payments. Learn more here.