Expect the NZD's paltry performance to continue till the looming elections and central bank FX intervention threat doesn't fade
NZD/USD expected level
Given a 'perfect storm' of rising US yields and greater NZ political uncertainty
The 2017 New Zealand General Election takes place on September 23 and is likely to command greater attention from NZD investors given the potential economic and policy implications at stake. While we have no house view on the outcome of the election, we note the prospective policies of the next government could be deemed NZD negative in either of the two likely scenarios:
Given the heightened domestic political uncertainty and prospects of significant policy changes by the next government, our base case for the kiwi dollar is to trade with a negative bias ahead of the elections. Indeed, while our AUD/NZD financial fair value model suggests the pair is trading with a modest upside skew in recent days, we would conclude there is scope for a more significant NZ political risk premium to be priced in. At peak political uncertainty ahead of the elections, there could be a further 1-2% idiosyncratic NZD weakness to capture the event risk.
The Reserve Bank of New Zealand has been saying no thanks to a strong NZD for a while now and ramped up its jawboning attempts in August by dropping the threat of intervention into the mix. While the threat of FX intervention remains non-credible at this stage – as the costs of an RBNZ rate cut in terms financial stability risks outweigh the benefits of a weaker NZD – we attribute part of the kiwi's recent underperformance to the verbal jawboning by RBNZ officials.
Earlier in the week, RBNZ Governor Wheeler reiterated the need for a lower currency and ongoing verbal jabs might see long NZD speculative positions neutralise further in the weeks ahead. Equally, a slowdown in house price growth is reducing any tail risk of near-term rate hikes to address any financial stability concerns; we note that three-year implied policy rates have fallen back towards their 2017 lows in recent months, thereby justifying the recent NZD weakness.
With speculative markets still significantly net long NZD and initial signs of a political risk premium yet to reach extreme levels, we suspect a narrower focus on the September elections could spell further weakness for the kiwi dollar. A data-driven recovery in USD sentiment could see NZD/USD temporarily undershoot our 0.71 forecast for 3Q17, with a break of the 200-DMA (0.7130) supporting this view.
Even worse, under a 'perfect storm' of rising developed market bond yields and greater domestic political uncertainty, we think NZD/USD could drop towards the 0.68-0.69 lows seen earlier in the year. We would also expect AUD/NZD upside to extend to the 1.11-1.12 area if markets see the NZD as an easy political target in the near-term.