NZ dollar loses its shine as world growth cools and interest rates fall

The NZ dollar has lost its shine as interest rates continue to fall. Photo/NZ Herald.

The New Zealand dollar, once the darling of yield seeking investors, has lost its flavour as interest rates plumb new lows and as concern mounts about world economic growth.

Since its float in 1985 the Kiwi has enjoyed a reputation as a high yielder - often allowing foreign exchange players access higher interest rates than can be achieved in their own countries.

The attractive interest rate differential has played a big part in the currency's often unwanted strength, especially from the Reserve Bank's perspective.

Those days are gone.

Or, as Kiwibank market strategist Mike Shirley puts: "We are standing on the pier waving goodbye, and that ship is on the horizon now."

With the Reserve Bank's official cash rate at an historical low of 1.5 per cent, there is little for foreign investors to get enthused about, particularly with the US Fed funds rate at 2.25 to 2.5 per cent.

And it looks like US rates are heading lower after the Federal Reserve this month shifted its emphasis to a more "dovish" stance.

Jason Wong, senior market strategist at Bank of NZ, said the Kiwi was also moving in sympathy with China's renminbi (RMB), which has come under downward pressure as trade wars start to weigh on that currency.

Depending on the outcome of G20 summit later this month in Japan, where US President Donald Trump and China's President Xi Jinping are expected to meet to discuss trade, more falls may be in store if the RMB continues to decline, Wong says.

The Kiwi last traded at US65.7c, after better than expected GDP data for March, but has lost about US5c since December last year.

US65c is seen as being an important support level.

"The New Zealand dollar is one of those commodity currencies that tends to be linked to the global economic cycle, so doubts about the world outlook tend to put downward pressure on the currency," Wong said.

"That's more so at the moment because China is at the epicentre of concerns about the global economy and, obviously, we have close links to China," he said.

The talk in the foreign exchange market is that China may allow the RMB to break through the 7 RMB to the US dollar level, if economic conditions worsen in the PRC.

It is almost there already, trading at 6.93 to the US dollar against 6.26 in March last year.

In the meantime, speculative activity in the Kiwi - people taking "long" positions in the currency to cash in on the once favourable interest rate differential - is not what it used to be.

"In fact, speculators are playing the short side - holding short NZ dollar positions - even if the currency is flat - and then clipping the ticket every day on the fact that interest rates are lower in New Zealand than in the US, so it's working in the opposite way to what we are used to," Wong says.

It used to be a bit of a "no-brainer" when New Zealand offered rates of 2, 3 or 4 per cent above US rates.

"That's been completely reversed, and there is a sense that this is not going to turn around any time soon."

While yield-seeking investors will be out of pocket, the same can not be said for New Zealand exporters, who are enjoying strong prices for dairy and meat, while enjoying a highly favourable exchange.

Kiwibank's Shirley said the Kiwi's decline took on a new lease of life when Reserve Bank Governor Adrian Orr signalled a rate cut on March 27. Orr then followed through with a cut to its current level of 1.5 per cent on May 8.

Reserve Bank Governor Adrian Orr. Photo/NZ Herald.

He said the world's central banks were in a "race to the bottom" with no one bank wanting to be out of step with the other.

The beneficial effect of a rate cut - a lower currency - can be wiped out in a relative sense if other central bank cuts further, he says.

"If everyone else starts cutting rates as well, then you need to cut more than the other guy in order to achieve that benefit of having a lower currency," Shirley said.

"You don't want to be the guy hiking or sitting on your hands when the rest of the world is doing something else," he said.

He said the Kiwi was increasingly being linked to the fortunes of the shaky looking RMB.

"I think the risks (for the Kiwi) are very much skewed to the south," he said.

"It's going to be a rocky road as we head in that direction."

Currencies are driven by interest rate differentials.

New Zealand's 1.5 per cent official cash rate (OCR) compares with 1.75 per cent in Canada, 0.75 per cent in the UK, and 1.25 per cent in Australia.

For the moment, the Reserve Bank is a long way off going into negative territory, as some central banks have chosen to do; Switzerland has an official rate of minus 0.75 per cent, Sweden's is minus 0.25 per cent and Japan's is minus 0.1 per cent.

ANZ, in a research paper, said that with a cash rate at just 1.5 per cent there was now a "very real" chance that monetary policy would run out of conventional ammunition in the next marked downturn which may be inspired, say, by a negative global shock, an extreme drought or an earthquake.

"Odds are rising that some kind of significant economic hit will occur before the OCR is back to anything approaching historical norms," the bank says.

"In such a situation, New Zealand's floating (sinking) exchange rate and fiscal policy will do their part in the adjustment, reducing the onus on monetary policy to get creative," the bank said.

"In this light, and given the risks, it is certainly not a given that taking New Zealand down the path of unconventional policy would be necessary or wise," ANZ said.