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The Week Ahead in FX Markets – The Tug of Trade Wars sees Kiwi Higher

Published January 14, 2019

The New Zealand dollar has battled higher over the weekend, making gains of 0.7% against the USD and 1.2% against the EUR. The sense we are getting is that markets are nervously optimistic. Optimistic that the US Federal Reserve will stop raising rates. Optimistic that equity markets will bounce back. Optimistic that US-China trade relations will improve. But nervous about Trump, the US Government shutdown, and in particular, Brexit.

Brexit Deal Vote – Time for Plan B

This week it will be the NZDGBP cross rate to watch, with the all-important Brexit deal vote on Wednesday NZ time, where the British House of Commons will vote on the current Brexit deal. It is expected the deal will get voted down – and the implications of this are unknown. The possibilities include:

  • Theresa May travelling to Brussels in an attempt to get further concessions
  • A second ‘Plan B’ vote on January 22 (NZ time)
  • An exit from the EU with no deal (deadline March 29)
  • A vote of no confidence in the current government, forcing a general election
  • An extension to the March 29 deadline (needing all EU member states to approve, so this is unlikely)

Fair to say – it is not a great situation to be in, and we can expect plenty of NZDGBP volatility. In 2016 when Britain voted to leave the EU, the NZDGBP traded in a 29% trading range. So if you’re exposed to Sterling – it is worthwhile being prepared for uncertainties.

The Kiwi – Where to From Here?

The direction of the New Zealand dollar is becoming more reliant on international events than ever, and these events are continuing to be unpredictable. Already in 2019, the kiwi has bounced from its interbank low just below 0.6600 cents to open this morning 3.5% higher. So, what does that mean for the kiwi? For now, the flightless bird appears to be caught in a tug of war – and below I break down the driving factors.

Pulling the Kiwi Higher

US Federal Reserve – Shifting Stance

The 3.5% 2019 snapback for the kiwi has mostly come on the back of shifting sentiment from the US Federal Reserve. As little as six months ago, markets had expected as many as 3-4 further Fed rate hikes in 2019. Now – markets are expecting as few as none – with some participants calling for a rate cut.

This is a huge shift in markets, with the equivalent of 1% in expected rate hikes, now off the table. Imagine if you were choosing to buy US dollars for a billion-dollar hedge fund – what does 1% means for your total returns? I know if it were my mortgage I would jump at the opportunity to save 1%. It is this change in interest rate expectation that is fuelling the downturn in demand for the USD. This theme looks set to be a key supporter for the NZDUSD pair in 2019.

Equity Market Confidence

US equity markets have kicked off 2019 with a bang – with the S&P 500 gaining around 10% since the 20-month low hit around Christmas just three weeks ago. Whilst there are still concerns around global growth, the early 2019 signs are that confidence is returning – and this is benefitting risk-sensitive currencies like the kiwi dollar. 

Easing Trade Tensions

Markets have become increasingly confident that the US & China will come to a more palatable trade agreement, as their 90-day truce continues. It is expected that Vice Premier Liu He will visit the US in January, and Trump said on Thursday that the US was having “tremendous success” in its negotiations.

The NZDUSD fell sharply when the trade war erupted, so it is safe to say that an end to the trade war would see those losses reversed. Whilst Trump is desperate for a win, the question for me is if he can achieve ‘tremendous success’ or if the trade war will continue to spiral. The kiwi will be sensitive to this – but for now the easing tensions are supporting a higher NZDUSD.

Pulling the Kiwi Lower

Trump and the US Government Shutdown

Democrats in Congress have rejected Trump’s $5.7 billion funding request for the border wall with Mexico, and they have refused further negotiations until the government is reopened after being partially shut down since December 22. The ongoing shutdown is expected to wipe as much as 0.4% off Q1 GDP and this is keeping 2019 growth expectations in check.

The Democrats are winning this battle by calling the wall ‘hypothetical’ and a ‘vanity project’. Trump now finds himself in a difficult situation, with recent polls showing that most Americans are blaming the president. Yet it is difficult to imagine Trump backing down from his staunch position – which means ongoing uncertainty for the US Government and thus markets.

General Market Nerves

As a risk-sensitive currency, the kiwi often moves with global risk sentiment. This can be difficult to measure, but there are still plenty of reasons for nervousness to continue in 2019 – and this is keeping the kiwi in check. This includes:

  • The possibility of US-China trade wars erupting once again
  • A slowing global economy, and the possibility of a recession (early signs have emerged in China and the US)
  • Political disruption either in the US, Britain or elsewhere
  • Recent stock-market jitters leading to a deeper market crash

These items are preventing the kiwi’s return to a 0.7000-0.7200 cent level. The ingredients are all there for a messy 2019 – it pays to be prepared.

Chart of the Week – NZD/USD Range Expectations in 2019

It can be a fools game to attempt currency predictions. Instead, it is better to prepare for all possible outcomes. At EncoreFX, we like to look at history and use market tools to anticipate the next 12-months trading range – knowing it could go up or down.

Each year, over the past 20-years, the NZD/USD has traded in an average trading range of 19.9%. Implied volatility (the markets own measure of anticipated risk), is showing at 9.7%. Whilst there are never any guarantees when it comes to FX predictions, the basic maths behind this number is that market pricing currently shows a 95% degree of probability that the kiwi will stay within the range shown below being +/- 9.7%. (Click image to enlarge).