NZD appears overvalued and vulnerable in a rising yield environment - AmpGFX

Greg Gibbs, Director at Amplifying Global FX Capital, points out that from a longer term perspective, NZD is one of the most over-valued currencies with respect to its narrowed yield advantage and the falling global yield environment of recent years may have contributed to this overvaluation.

Key Quotes

“If we are moving into a rising global yield environment, we might expect NZD to become a much weaker currency, potentially reconnecting to its narrowed yield advantage.  A fall to below 0.60 would not be a stretch at all.”

“High Debt levels to work against NZD and AUD in a rising yield environment

A fundamental factor that may help drive the NZD and AUD lower over the medium term is the impact of higher global yields on the Australian and New Zealand economies.  Both countries have much more highly leveraged households after surges to record highs in their house prices relative to household income in recent years.  As mortgage rates begin to rise, it will dampen growth in Australia and New Zealand faster than in the USA.

Their regulators have forced banks to adopt longer-term funding sources.  This means that mortgage rates in both countries are now more influenced by global bond yields than in past cycles.

In the falling yield environment until Q3 last year, this tended to place downward pressure on mortgage rates in Australia and New Zealand, reinforcing housing market strength.  In a rising global bond yield environment, mortgage rates in Australia and New Zealand will start to rise faster than official rates, tending to weaken their housing markets and consumer demand.

In any case, regulators in New Zealand and Australia are leaning harder against bank mortgage lending.  Banks have been required to lift their credit standards and slow lending.  This has to some extent allowed both countries to cut official interest rates further in the last year.

Importantly, there will be no tears shed in by governments or central banks in Australia and New Zealand if their exchange rates fall significantly from current levels.

Both would prefer a balance of policy that involves a weaker exchange rate and higher interest rates.  New Zealand, in particular, has said that its exchange rate needs to fall.”