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New Zealand economy benefitted from China’s seemingly insatiable demand, but in a much different way. New Zealand is a leading agricultural commodity exporter to China, mainly milk, beef, fruits and vegetables. It wasn’t so much a demand issue for these consumer staples as it was a global supply issue. An untimely removal of EU dairy production caps resulted in a global rush to increased production to capture or maintain market share, much in the same way global petroleum producers reacted to collapsing prices. The end result was a collapse in dairy prices. In hindsight, this may have been a silver lining for the RBNZ as it caused the central bank to embark on a steady, measured rate cutting cycle. On the other hand, the RBA had cut early in 20152 but halted in May at 2.00%, perhaps expecting a rebound in China’s economy.

In the first half of 2015 the Kiwi strengthened to near parity after the RBA reduced to 2.25% then reversed, trending to NZD $1.13689; a decline of 13.7%. After the 10 September RBNZ OCR reduction the Kiwi gained 6.697% to NZD $1.0546 by 3 November. The chart seems to indicate that markets expected the RBA to act by that time, but after the 3 November decision to maintain, the Kiwi reversed, weakening about 4.31% right up to the next RBA meeting, reversed and strengthened right through the 10 December RBNZ OCR rate cut to NZD $1.0598 by 29 December. The cross followed the same pattern of gains and losses right through the BOJ and ECB QE expansions. The most recent RBNZ reduction did not have much effect vs the Aussie, however. Over this entire narrative, the RBNZ maintained a positive, but shrinking carry over the RBA; from 125 basis points to 25 basis points, until 2 May when the RBA reduced 25 basis points increasing that spread to 50 basis points.

From 25 April, the Kiwi began a sharp strengthening trend leading up to the 2 May RBA rate reduction. What is the likelihood of a further strengthening from here?  That may depend much more on the Australian economy that the New Zealand economy. Once again it comes down to exports. Demand for consumer staples is relatively non-cyclical, whereas demand for industrial commodities is very much dependent on global growth cycles.

In the 2 May statement, Governor Glenn Stevens noted that “...Commodity prices have firmed noticeably from recent lows, but this follows very substantial declines over the past couple of years. Australia's terms of trade remain much lower than they had been in recent years...” Clearly, Governor Stevens was indicating a longer term view on the situation.

...In Australia, the available information suggests that the economy is continuing to rebalance following the mining investment boom...”  Again, this is the issue with every industrial commodity producer-exporter and noted in the statement, although indirectly: “...Inflation has been quite low for some time and recent data were unexpectedly low. While the quarterly data contain some temporary factors, these results, together with ongoing very subdued growth in labour costs and very low cost pressures elsewhere in the world, point to a lower outlook for inflation than previously forecast...”

Clearly, the RBNZ would prefer a weaker Kiwi vs its major trading partners. New Zealand’s largest single export to Australia is Crude Petroleum at 17%. The other major exports include dairy at 10% and other foodstuffs at 22.4%. However, Australia already has a sizable dairy and agriculture industry. The point being that terms of trade between the two may not be seriously affected by a slight strengthening of the Kiwi and if past is prologue, the cross is likely to remain in its range of the past 6 months:  between (12 month) Fibonacci retracement levels NZD $1.0534 support and NZD $1.1308 resistance.

Mike Scrive
Technical Analyst
Accendo Markets

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1 RBA media release 2-5-2016
2 The RBA rate cutting cycle reaches back to November 2011, from 4.50%.