High yielders running out of steam?

The Reserve Bank of New Zealand (RBNZ) has been on a tear this year, hiking interest rates five
times as of mid-October. Analysts say another .25 basis point rate hike is likely in the cards at the Oct.
28 meeting. If that materializes, it would push the official cash rate there to a whopping 6.50 percent
the highest in the industrialized world.

This aggressive monetary tightening helped the New Zealand dollar (NZD) be one of the strongest currencies against the U.S. dollar in the third quarter. The NZD has rallied from its 2004 low, hit in late May at 0.5912, to near the 0.6950 area in late OctoberBut the fast pace of tightening by the RBNZ could actually backfire and weaken sentiment for the NZD looking ahead. Fears that the RBNZ overtightened, which could actually weigh on economic growth in New Zealand, could depress the currency.

“They may have to pull a Bank of Canada and cut rates in the first quarter of 2005,” says Tom Rogers, senior currency strategist at Thomson Financial. (The Bank of Canada abruptly shifted
gears in its monetary stance mid-year in 2004.)

“The RBNZ has been hiking in a slowly growing global environment and we all know that everything is interrelated,” he adds. Slower growth forecasts for the country have already been issued by the RBNZ, with GDP seen at a 2.5 percent year-over-year rate in the first quarter 2005, vs. second quarter 2004’s
strong 4.4 percent year-over-year pace. Sean Callow, currency strategist at Ideaglobal, echoes Roger’s concerns.

“They might have been too aggressive on their rate hikes,” he says. “While their economy is doing well, they need to be paying more attention to the global economy.”

In addition to concerns over sustaining economic growth amid the tight monetary policy atmosphere, the NZD is hurtling straight toward major psychological and chart resistance at the 0.7100 level, the February 2004 price peak.

“The 0.7000 area is a tough barrier,” says Callow. “Psychologically, that means a lot to the Kiwis. They are worried about their competitiveness at that level. They are very reliant on selling their products to the world and they don’t want to be burdened by a high exchange rate.”

Just this year, New Zealand passed legislation permitting the RBNZ to intervene if the exchange rate is exceptionally high or low. As the NZD approached that 0.7000 level in late October, the New Zealand Finance Minister made statements suggesting the administration was not “comfortable” with the level of the NZD. Speculation of intervention if the NZD moves above the 0.7000 level could provide the currency with a tough ceiling.

“I wouldn’t be buying it here at 0.6900,” says Callow. “At these levels, I’d be leery of coming in and chasing the market higher,” agrees David Solin, partner at FX Analytics.