The Reserve Bank of New Zealand is all set to raise its benchmark interest rate at its monthly monetary policy meeting Thursday. The market expectation is for Governor Graeme Wheeler to announce a 25 basis point hike to 2.75 percent, from the current level of 2.5 percent.
In the zero-interest-rate policy (ZIRP) environment, where monetary policy in the developed world has been defined by interest rates near or at the zero bound, New Zealand will become the first developed country to be raising interest rates.
This unique position and the higher interest rate differential will make the New Zealand dollar, or the Kiwi as referred to by traders, one of the favourite long positions within the developed market currency space.
Last year, the Kiwi was relatively unchanged in US dollar or British pound terms. But it showed enormous out-performance against the Australian dollar and the Japanese yen. It appreciated more than 10 percent against both the Aussie dollar and the yen, with the Aussie/Kiwi cross hitting a five-year low.
Above trend growth and a strong recovery in the housing market has raised concerns over inflation with the central bank officials. Not only is New Zealand the first developed country to be hiking interest rates, its central bank said it was expected to raise rates to 4.75 percent (another 225 basis points from the current level) over the next two years.
Compare this to the dovish forward guidance given by the US Federal Reserve, the European Central Bank (ECB) and the Bank of England, who will still intend to maintain record low rates (for the next 1-2 years) even after strong recoveries in their respective economies.
Thus, in the coming years, New Zealand will offer the highest interest rates in the developed market space and investors will be attracted to this high beta currency.
The GDP growth is expected to maintain its momentum. Last year, the economy surprisingly absorbed severe slowdown in two of its most important trading partners - China and Australia. For the year ending March 31, 2014, the country is expected to grow at an annualized pace of 2.7 percent and according to the Treasury's half-year economic update, this growth is expected to rise to 3.6 percent in the year to March 2015.
An interesting point to note is that 35 percent of New Zealand's exports come in the form of milk and dairy products. Approximately 90 percent of New Zealand's milk powder is sold to China and as the middle class in China and India grow, their demand for milk and protein will increase according to BK Asset Management.
This "soft vs hard" commodity play is the reason why a slowdown in China will cause the Aussie dollar to under-perform (as Australia exports hard commodities) while the Kiwi can absorb the shock of a Chinese slowdown.
Going forward, bets should be laid on the New Zealand dollar to strengthen against the Japanese yen, Australian dollar and the euro. The Kiwi-dollar cross should remain range bound as the US Fed taper may lead to a rally in the greenback, which has been weak off late due to the weak weather related economic data.
(Vatsal Srivastava is a senior market analyst. The views expressed are personal. He can be contacted at firstname.lastname@example.org)