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On Valuation terms: NZD remains overvalued, while milk powder prices have stayed depressed and inflation in New Zealand has surprised to the downside.
NZD TWI strength is a major concern, together with downside risks to global growth. But TWI strength is not solely yield driven. Growth matters too and lowers interest rates are stimulating growth. The Canadian dollar offers better value, and should continue to benefit from more stable crude oil prices and the US economic recovery.
Disinflation: New Zealand is suffering from disinflationary pressures, with reported CPI inflation well below the RBNZ’s 1-3% target range. It is also more exposed to China growth risks than Canada.
Chinese trade exposure: New Zealand has a very export-driven competitive economy with exports accounting for about 30% of GDP.
Most notably, China has been the major trade partner of Kiwis, China overtook the United States at the end of 2008 to become New Zealand's second-largest trading partner, with bilateral trade amounting to $12.7 billion in the year ended September 2011. Chinese demand for New Zealand commodity exports, especially dairy products, and logs, has risen rapidly in recent times and has been the major factor in the recent surge in New Zealand's commodity prices and terms of trade.
OCR and Short End: Kiwis interest rates are high in a global comparison, we expect the RBNZ to cut the OCR by 25bps a piece in August and February, taking the OCR to 1.75%. This is more than fully priced, but even so, we expect the short end to remain under downward pressure as the market explores the possibility of deeper OCR cuts.
Recommendation: Short NZD/CAD is a relative value trade with low correlation to global market trends.
