'Carry trade' less of a factor in NZ dollar market

Photo / Kenny Rodger

The impact of the so-called 'carry trade' on the value of the New Zealand dollar has diminished during and since the global financial crisis, according to an article in the latest Reserve Bank of New Zealand (RBNZ) Bulletin.

Enzo Cassino and Zoe Wallis of the central bank's financial markets department said their model of the NZ dollar identifies several instances during the past three years when the key exchange rate driver has changed from relative interest rates to investors' risk appetite.

Before the global financial crisis, movements in the NZ dollar were dominated by the impact of the carry trade, which typically involves borrowing in a country with low interest rates like Japan and investing in higher-yielding currency assets like the NZ dollar.

"As global exchange rate volatility has increased, and international investors' risk appetite has diminished, the impact of carry trade on the value of the NZ dollar appears to have diminished," the article said.

Prior to the crisis the NZ dollar was trading at an all-time high on a trade-weighted basis.

From September 2008 to around March 2009 the NZ dollar experienced a sharp depreciation against most of its major trading currencies.

Since then it has reversed most of its losses but is still around 10 per cent to 12 per cent down on the 2007 peak.

To a large extent the NZ dollar's moves against major currencies have been substantially driven by the fundamentals of the other economy rather than domestic factors in New Zealand.

The moves were also partially driven by liquidity.

During the crisis the spread between bid and offer, or buy and sell quotes, widened and traders reported poor liquidity, or ease of trading, for most of 2009.

Turnover volumes in the NZ dollar market declined by around 30 per cent over the crisis period compared to typical volumes between 2005 and 2007.

Volumes have tended to remain lower compared to before the crisis.

"The Reserve Bank's market contacts have confirmed that liquidity conditions are only slowly recovering relative to the peak of the crisis," the article says.

The NZ dollar is generally getting less attention from international investors compared to before the crisis.

The volatility of all currencies increase sharply during the crisis.

"Increased exchange rate volatility has had a significant impact on the attractiveness of international investment strategies such as the carry trade," the article said.

The authors note that some commentators have argued that the crisis has seen a permanent change in the behaviour of global financial markets.

The RBNZ concludes that it is too early to determine the impact of the crisis on long-term trends in the NZ dollar market.

- NZPA