New Zealand bears

July 25, 2018 12:11 PM
Trades: Forex

When it comes to the forex market, the New Zealand dollar punches well above its weight. New Zealand famously has a larger population of sheep than people, and the country’s GDP ranked just 70th among individual countries last year (behind powerhouses such as Greece, Uzbekistan and Ecuador). 

Nonetheless, the New Zealand dollar, colloquially referred to as the kiwi, is the 10th most traded currency, involved in 2.1% of forex transactions. 

From an economic perspective, the kiwi is a quintessential commodity currency, with its performance closely linked to the value of its major exports, primarily dairy products, beef and lumber. In addition, the country has historically offered relatively high-interest rates for a developed nation, making it a key cog in the global carry trade. Due to these factors, the performance of the New Zealand dollar/U.S. dollar (NZD/USD) currency pair has been closely correlated with traders’ risk appetite, which is a previous tailwind that died down at the end of January.

Since cutting its benchmark interest rate to a record low of 1.75% in late 2016, the Reserve Bank of New Zealand has been on hold for 18 months. By contrast, the Federal Reserve has raised interest rates on six occasions during that same period, bringing the Federal funds rate to near parity with New Zealand’s.  Despite the narrowing interest rate gap, NZD/USD has held up relatively well, carving out a broad range between 0.6800 and 0.7500 during the last two years.

The pair got off to a stellar start leading upt to 2018, rallying from the bottom of the range near 0.6800 in mid-December up to nearly the top of the range above 0.7400 by late January. Rates then spent the next three months consolidating within the smaller 0.7200-0.7400 range before a big breakdown in late April.

From a price action perspective, the late April breakdown showed an historically rare streak. From “Tax Day” on April 17 until April 26, NZD/USD traded lower for eight consecutive days. Since 1982, a sample that includes nearly 10,000 trading days, this represents only the 20th such eight-day bearish streak. 

While the historical record suggests that rates often see a near-term oversold bounce after such streaks, the medium-term outlook surprisingly favors the bears. During the last 19 occurrences, NZD/USD has seen an average gain of 0.5% over the week following an eight-day losing streak. Looking out a bit further, the performance during the next month is less compelling (an average gain of just 0.05%) and during the next three months, the average NZD/USD return following an eight-day bearish streak is actually slightly negative. 

This is a pattern we’ve identified in a variety of currency pairs, as well as other markets: While long streaks of consecutive days trading in the same direction can get overdone in the short-term, they often signal a continuation in the same direction over medium-term horizons.

As for the NZD/USD, the relative interest rate advantage should continue to shift in favor of the greenback this year. That said, the Federal Reserve is, by its own admission, nearing its target interest rate; so the Reserve Bank of New Zealand could look to take that advantage back in 2019, if the global economy continues to grow apace. Technically speaking, swing traders should continue to keep an eye on the 0.6800-0.7500 range; a breakout could foreshadow a continuation in the same direction, but as long as those levels hold, the longer-term technical bias in the pair remains neutral.  

About the Author

Senior Technical Analyst for FaradayResearch. Matt has actively traded various financial instruments including stocks, options, and forex since 2005. Each day, he creates research reports focusing on technical analysis of the forex, equity, and commodity markets. In his research, he utilizes candlestick patterns, classic technical indicators, and Fibonacci analysis to predict market moves. Weller is a Chartered Market Technician (CMT) and a member of the Market Technicians Association.