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Over recent years the New Zealand dollar has become a prominent traded currency in the global market place, laying claim to the 10th most traded currency in the world.As CMC markets celebrates our 10th anniversary in New Zealand, we take a closer look at what makes our dollar tick and whether it can continue its outperformance over that of much larger economies.
The exchange rate of the New Zealand dollar is largely a function of the performance of our economy and political stability, along with our monetary and fiscal policies contrasted against those of other countries and regions. Over recent years we have seen our currency fluctuate greatly across most of our trading partners from the US, China and most recently with Europe and Britain, as they continue economic and political transitions.
The trade-weighted index, often mentioned by economists, is a measure of the relative strength of our dollar against the currencies of our biggest trading partners. China is now our largest trading partner surpassing Australia, followed by Europe and the United States. This also reflects an important change in the economic focus of our country over the last decade or so, towards a more regional weighting and the prominence of China in the region. Although the use of the Chinese Yuan is growing, many of our companies trading with China still chose to use the US dollar. This adds to the NZD/USD flows, making it our top traded currency pair.
While trade related flows, both commercial and private, plays a big role in the exchange rate,
The biggest flows in the New Zealand dollar are for speculative reasons. Interest rates offered between the two traded currencies is also known as the 'carry trade'. This is where a currency such as the Yen that offers near zero or negative rates of interest is sold, and a currency with a higher rate of interest like the Kiwi dollar is bought to profit from that differential in interest rates.
As many central banks around the world have aggressively cut interest rates, the carry trade-related flows into our dollar has increased strongly. We have also seen an increase in speculative flows from the Euro as some of their interest rates are now negative.
Traders and businesses in Australia and New Zealand also pay close attention to the interest rates, and future expectations around interest rates in the two countries, as it can influence the exchange rate between NZD/AUD. The performance of iron ore and that of dairy the other important markers on their watch list. We have seen the Kiwi test parity on several occasions over the past decade, and some are suggesting that we may finally reach parity over the next year.
Looking forward, the New Zealand economy has cooled down somewhat after being dubbed the "rock star" economy a few years ago, largely due to the downturn in dairy. It has highlighted the potential danger to our economy of being exposed to a single industry and also to a single big customer such as China. We have since seen other parts of our agricultural sector pick up the slack while other success stories in the tech and engineering sector help keep New Zealand positioned as one of the top performing economies in the OECD.
Should New Zealand continue to be able to build a more balanced economy across our agricultural sector; and continue to invest in our innovative engineering and tech firms; it could provide a more robust economy that will be able to better withstand external shocks which could also attract more productive capital and see the New Zealand dollar continue to punch above its weight in the future.
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