September 2016

New Zealand Update

The latest dairy auction saw prices increase by 7.7% with the key whole milk powder up 3.7%.

Fonterra’s recently revised forecast for the season 16/17 of $4.75/KgMS is up from the opening forecast $4.25/KgMS. It is however, still below the estimated average cost of production of $5.05/KgMS for this season. Losses continue to be the reality for conventional producers although the mood is certainly improved. It is still early in the season. The organic forecast is unchanged at $9.20/KgMS.

New Zealand’s terms of trade fell 2.1% in the second quarter. The increase in oil and a dairy product decline combining to create the fall.

The NZ commodity price index rose for the fourth month in a row in August up 11% on an annual basis but fell 0.5% on an NZ$ basis as currency strength negatively impacted on export returns. Dairy prices led the gains up 8.3%.

New Zealand Dollar/Interest Rates

New Zealand Dollar

NZD/USD is currently trading at .7225. NZD/TWI is currently marked at 77.25. Both rates are some 4% higher than when we last commented in the second quarter 2016, in spite of an RBNZ rate cut and strong indications of more cuts to come. Bank of New Zealand currency models (both short term and long term) tell us these levels are at around fair value given the improvement in terms of trade which has resulted from the recent rise in dairy commodity prices. Technically, the NZD/USD looks to have topped out for the time being. It is likely that the most important influence on the currency in the near term will be the US Federal Reserve, and any decision and accompanying commentary it makes at the September FOMC meeting. If the Fed raises rates, renewed USD strength is likely to see NZD/USD pairing trade lower.

New Zealand Interest Rates

NZD cash rate is 2.00%. The NZ 10yr bond is 2.25%. The RBNZ cut rates at its August meeting and suggested more rate cuts would be required to get inflation back to the 2% target. The commentary told us a lower currency was desirable in order to generate tradable inflation at appropriate levels. To date the currency is not really trading lower, and at face value further cuts look likely. However, as with the currency, much will depend on the US Federal Reserve. If the Fed raises rates, and the NZD/USD trades lower, the RBNZ may well hold off cutting rates again this year. We certainly expect them to be on hold at the September OCR review. All else being equal, we expect the October inflation print to be low and annualized CPI to print around zero. The NZ economy continues to perform well on a relative basis, and the NZ terms of trade have improved as a result of improved commodity prices. And the residential property market is still hot. A confusing picture and it is not clear that lower rates in New Zealand will achieve any of the outcomes traditionally associated with cheaper money.

The NZ 10yr bond rate is captive to offshore bond market moves. The global search for yield has not abated, and the BOE response to Brexit only exacerbated the supply shortage. Again, the US fed will be a big driver of moves in the short term. We continue to expect NZ 10yr bond to trade in a 25bps-75bps margin over the official cash rate for 2016.

Reading the Charts

The NZD moved sharply higher over the last quarter. This was most notably against the pound as a result of the unexpected ‘Brexit’ result.

Last updated 09/09/16, Source: Reserve Bank of New Zealand, Reuters, NZFMA

The NZ economy remains positive, and although fears the Auckland residential housing market is becoming extremely overvalued remain strong, growth forecasts are bullish, supported by recent dairy auction strength.

Last updated 09/09/16, Source: Reserve Bank of New Zealand, Reuters, NZFMA

As usual global market sentiment will continue to influence the movement of the NZ$ with yield and economic performance supporting NZ$ strength.

Last updated 09/09/16, Source: Reserve Bank of New Zealand, Reuters, NZFMA

The strong recent uptrend is intact although purely from the chart point of view there is clear risk to the downside in the next quarter even if only a corrective pause.