How to trade New Zealand dollar futures contracts

By | May 29, 2017

New Zealand dollar futures contracts have a tight correlation to the Australian dollar. The NZD is somewhat similar to the AUD due to the fact that both Australia and New Zealand are not only geographically closer, they also share somewhat similar characteristics in trade as well.

Still, some of the major benefits of trading the New Zealand dollar over the Australian dollar is the fact that with the NZD futures contracts, exposure to China is somewhat limited as compared to the Australian dollar.

Furthermore, besides being a commodity linked currency, the New Zealand dollar is heavily influenced by dairy and meat prices, unlike the Australian dollar which is mostly linked to Iron-Ore.

In this article we will cover the basic fundamentals required for a day trader in order to successfully trade the New Zealand dollar futures contracts.

Economic Overview of New Zealand

New Zealand is a very small economy with GDP valued at approximately $174 billion USD in 2015.

New Zealand GDP: 174 billion USD, 2015

New Zealand GDP: 174 billion USD, 2015

The country’s population is actually equivalent to less than half of the population of New York City. It was once one of the most regulated countries within the OECD (Organization for Economic Co-operation and Development), but over the past two decades has been moving towards an open, modern and stable economy.

New Zealand also has highly developed manufacturing and services sectors, with the agricultural industry driving the bulk of the country’s exports. The economy is strongly trade-oriented, with exports of goods and services representing approximately one third of GDP.

Due to the small size of the economy and its significant trade activities, New Zealand is highly sensitive to global performance, especially as it relates to its key Asian trading partners, Australia and Japan.

Together, Australia and Japan represent 30 percent of New Zealand’s trading activity. During the Asian Crisis, New Zealand’s GDP contracted by 1.3 percent as a result of reduced demand for exports, and two consecutive droughts from reduced agricultural and related production.

Monetary & Fiscal Policy

The Reserve Bank of New Zealand (RBNZ) is the monetary policy authority of New Zealand.

Meetings on monetary policy occur eight times a year or approximately every six weeks. Unlike most other central banks, the decision for rate changes rests ultimately on the bank’s governor.

The current policy target agreements set by the minister and the governor focus on maintaining policy stability and avoiding unnecessary instability in output, interest rates and the exchange rate.

Price stability refers to maintaining the annual consumer price index (CPI) inflation at 1.5 percent.

New Zealand key inflation rate since 1990

New Zealand key inflation rate since 1990

If the RBNZ does not meet this target, the government has the ability to dismiss the governor of the RBNZ. However, this is rarely the case.

This serves as a strong incentive for the RBNZ to meets its inflation target. The most common tools used by the RBNZ to implement monetary policy changes are the following:

The Official Cash Rate (OCR)

This is the rate set by the RBNZ to implement monetary policy. The bank lends overnight cash at 25 basis points above the OCR rate and receives deposits or pays interest at 25 basis points below this rate.

By controlling the cost of liquidity for commercial banks, the RBNZ can influence the interest rates offered to individuals and corporations. This effectively creates a 50 basis point corridor that bounds the interbank overnight rate.

Banks offering funds above the upper bound will attract few takers because funds can be borrowed for a lower cost from the RBNZ. Also, banks offering rates below the lower bound will also attract few takers, because they are offering lower yields than the RBNZ.

The official cash rate is reviewed and manipulated to maintain economic stability.

Open Market Operations

This is used to meet the cash target. The cash target is the targeted amount of reserves held by registered banks. The current target is NZ$20 million.

The RBNZ prepares forecasts of daily fluctuations on the cash target and then will use these forecasts to determine the amount of funds to inject or withdraw in order to meet the cash target.

Important Characteristics of the New Zealand dollar

Strong correlation with AUD – competition with Australia

Australia is New Zealand’s largest trading partner. Because of the proximity of the two nations, New Zealand’s economy is closely partnered with that of Australia’s.

When the Australian economy does well and Australian corporations increase their importing activities, New Zealand is one of the first to benefit.

In fact, since 1999, the Australian economy has done very well, with for example, a booming housing market that created a need to increase imports of building products. As a result, this strength translated into Australia importing 10 percent more goods from New Zealand between 1999 and 2002.

Commodity-linked currency

Exports form the major portion contributing to New Zealand’s growth. Commodity exports represent over 40 percent of the country’s exports.

As a result, the currency has a 50 percent positive correlation with commodity prices. As commodity prices increase, the NZD will also appreciate. The correlation between AUD and NZD also contributes to the NZD’s status as a commodity-linked currency.

Australia’s economic performance has a strong correlation to commodity prices. Therefore, as commodity prices increase, the Australian economy benefits. This translates to increased activity in all aspects of the country’s operations. The trade sector being one among the many.

Carry trades

With highest interest rate of the industrialized countries, the NZD is one of the most popular currencies to buy for carry trades.

Interest rate differentials between the cash rates of New Zealand and short-term interest rate yields of other industrialized countries are significant. The New Zealand dollar is always in demand, pushing the exchange rate higher. This is due to the increasing demand for the NZD due to higher interest rates.

Interest rate can be good indicators of potential money flows as they indicate how much premium yield NZD short-term fixed income assets are offering over foreign short-term fixed income assets, or vice versa.

This differential provides traders with indications of potential currency movements. Investors are always looking for assets with the highest yields making NZD a prime currency of interest.

Population Migration and influence on the NZD economy

New Zealand has a very small population.

Therefore increases in migration into the country can have significant effects on the economy. New Zealand’s population increased by 37,500 between 2002 and 2003. Comparatively higher than the 1,700 increase between 2001 and 2002.

This strong population migration into New Zealand has contributed significantly to the performance of the economy. As the country’s population increases, demand for household goods increases too. This leads to an increase in overall consumer consumption.

The New Zealand economy’s exports are mostly commodities. Therefore, the country’s GDP is very sensitive to severe weather conditions. Weather can play havoc with the country’s farming sector.

In 1998, droughts cost the country over $50MM. In addition, droughts are also very frequent in Australia, New Zealand’s largest trading partner.

The droughts cost Australia as much as one percent of GDP. This translates to weaker exports from New Zealand.

Important Economic Indicators for Australia

  • Gross Domestic Product (GDP)
  • Consumer Price Inflation (CPI)
  • Balance of Goods and Services
  • Private Consumption
  • Producer Price Index (PPI)

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