RBNZ FX intervention threat amp NZD implications

Reserve Bank of New Zealand Graeme Wheeler resorted to the threat of intervention last night, saying: “It would become more opportune for the Reserve Bank to intervene in the currency market to sell New Zealand dollars” if the currency failed to respond to worsening fundamentals. We are not sure whether Wheeler’s statement implies that fundamentals have started to deteriorate or if he is anticipating a slowdown ahead.

Wheeler added that if the Kiwi strength persists to the extent of slowing tradables inflation, it “will be a factor in our assessment of the extent and speed with which the Official Cash Rate needs to be raised”.

FX traders are well aware of the ineffectiveness of past RBNZ interventions and how they had little effect, especially if not accompanied by actual policy easing. The NZ government last year even likened NZD intervention with being in a “war zone with a peashooter.”  Indeed, accelerating house prices, increased hiring and robust business confidence surveys continue tog price at least two interest rate hikes year, in addition to the 50-bps delivered earlier this year.

Wheeler’s interventionist remarks emerged hours after the release of the NZ Q1 unemployment rate coming in steady at 6.0% vs. expectations of 5.9%, and an employment growth of +0.9% from the previous 1.1%, vs. expectations of +0.6%. The participation rate, however, hit a record high of 69.3% in Q1 from Q4’s 68.9%. On the disinflationary side, NZ private sector labour costs was halved in Q1 to 0.3% vs. an expected 0.5%, with 1.6%y/y.

Our previous piece on the Kiwi from February 20 predicted a 4% rise in NZDUSD partly due to further gains in dairy, meat & poultry prices. NZDUSD ended up raising more than 6%. But is today different?

Falling dairy prices & rising farmer debt

Until the Wheeler remarks, the NZD was oblivious to the 6^th consecutive decline in dairy product prices recorded by Fonterra’s Global Dairy Trade auction, held by the world’s biggest producer of dairy products. Expectations are now pointing that Fonterra will trim its forecast for a record milk payout. The combination of lower milk payout to farmers with a strong currency could intensify farmers’ indebtedness towards the breaking point, especially if interest rates continue to rise, as they’re expected.

NZ’s dairy whole milk powder prices fell 23% so far this year to US$3,930 a tonne, nearing the lowest level since Feb 2013.Wheeler warned over the potential slowdown of NZ’s dairy exports to China as the world’s 2^nd largest economy cools off from the double-digit growth rates of previous decade.

If NZD appreciation remains maintained by higher interest rates, then downside surprises from Fonterra’s payout will become too frequent and inflation decline becomes more sustainable. That would be NZD-negative. But betting on a NZD decline mainly based on threats of RBNZ intervention could prove costly, especially if two more rate hikes are priced in. Rather than shorting NZD vs USD, the preferred trade remains in in capping the bounce in NZDJPY and supporting AUDNZD towards 1.11.