FX Watch: NZD: more bearish but near term upside risks

by: Roy Teo

We are more bearish on the New Zealand dollar (NZD) as we now expect more aggressive rate cuts from the central bank. Hence we have lowered our 2015 and 2016 year end NZD forecast to 0.65 (from 0.68) and 0.62 (from 0.64). However, in the short term, downside risks have diminished as markets are already aggressively positioned for NZD weakness.

 

More bearish NZD/USD forecasts…

We now expect the Reserve Bank of New Zealand (RBNZ) to lower the Official Cash Rate (OCR) by 25bp each in the third and fourth quarter of this year. As a result, we have lowered our 2015 and 2016 year-end forecast to 0.65 (from 0.68) and 0.62 (from 0.64) respectively.

…because we are negative on the NZD in the long term…

We remain fundamentally bearish in the NZD/USD in the long term due to divergence in monetary policy between New Zealand and the US. Narrower interest rate differentials are expected to push the  NZD/USD lower towards 0.62 by the end of 2016. Furthermore, the New Zealand dollar remains more than 10% overvalued against the US dollar. In case there is a significant relief rally in the New Zealand dollar, it is likely that the RBNZ will become more dovish. This in turn will weigh on the currency. We maintain our short NZD view versus the US dollar; the position has yielded a total return of more than 7%.

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…however, lower downside risks in the short term

On 11 June, the RBNZ surprised financial markets (including us) by lowering the OCR by 25bp to 3.25% and signalled another rate cut in the coming months. We had forecast that the RBNZ will only lower the OCR in the last quarter of this year. As a result, the NZD has declined by more than 4% against the US dollar and against its trade weighted basket of currencies. The NZD trade weighted index is now lower than the RBNZ projections by the end of this year. Hence the RBNZ is likely to be less dovish on the strong exchange rate in the coming months. Technical indicators in the weekly chart also imply that the NZD is in oversold territory and hence further downside risks in the short term have diminished. This is further reinforced by the fact that the bearish sentiment in the NZD is also near extreme. In addition, speculative short futures positions in the NZD are at record highs.

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Furthermore, the options market demand (short-term) to hedge downside risk in the NZD has also continued to decline. Last but not least, in our view financial markets are too aggressive in the magnitude of rate cuts within the next quarter. Taking the above into consideration, we have left our 2015 Q3 NZD/USD forecast unchanged at 0.69.

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