NZD/USD: Depreciation bias intact - Nomura

FXStreet (Delhi) – Charles St-Arnaud, Research Analyst at Nomura, believes that NZD/USD will continue to depreciate into year-end and early next year, as a result of the narrowing of the rates differential (Fed hiking and RBNZ cutting) and because of the further decline in milk prices.

Key Quotes

“The NZD terms of trade have deteriorated in recent weeks, especially given the decline in milk prices. However, the impact of the decline in exports prices on the terms of trade is softened by the decline in oil prices, which also pushed import prices lower. Milk futures are suggesting that milk prices could fall further by about 5% before the end of the year.”

“Moreover, with milk imports from China remaining low, while supply is expected to increase, especially from the US, we believe a sharp rebound in the price of milk remains unlikely next year, as we have shown in FX Insights - NZD: More cuts to come, and believe that milk prices are likely to stabilise next year. Moreover, we see risks that the strong El Nino this season could disrupt the agricultural sector output, which would be a drag on growth.”

“Based on the current level of commodity prices, we estimate NZD/USD fair value to be around 0.64, meaning that the cross is not overvalued at current level. On a TWI-basis, we estimate that NZD could be overvalued by about 2%, which is very small and well within the confidence interval. These results suggest that there is no need for a significant decline in NZD unless fundamentals deteriorate.”

“We continue to expect the RBNZ cut rates at the December meeting as the RBNZ continues to say that “some further reduction in the OCR seems likely” and the central bank is concerned about the impact of the recent NZD appreciation on the inflation outlook.”

“Currently, a rate cut is fully priced in by the March meeting, while markets are pricing in about a 45% probability of a cut by the end of the year. We believe that continued weakness in inflation, leading to a further decline in inflation expectations, coupled with the underperformance in the labour market, will mean that the RBNZ is likely to want to provide some further stimulus to the economy.”

“We believe that NZD/USD is likely to stabilise at a level of 0.62, as milk prices are likely to remain steady and maybe increase slightly.”
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