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FX analysis

USD, Fed, RBNZ to keep NZ dollar on its toes

NZD/USD and two year swap yield chart

NZD/USD endured a volatile 2021, lifting to a high around 0.7465 in mid-to-late March, and depreciating towards its 2021 lows of 0.6702 in late December, despite two interest rate rises from the RBNZ in Q4 2021.

The 2021 high in NZD/USD coincided with a multi-year high in global dairy prices, generating a boom for New Zealand’s largest commodity exporters. Local New Zealand business sentiment was also buoyant early in the 2021 thanks to very strong New Zealand GDP growth.

Driven by the steady pick-up in economic activity, New Zealand’s two-year yields lifted over 2021 and continued to rise strongly, reaching four-year highs in Q4 2021 (see chart). The rise in New Zealand’s bond yields reflected the steady rise in New Zealand’s inflation over the course of 2021, to a high of 4.9% by Q3. Due to the small nature of New Zealand’s open economy, New Zealand’s GDP growth picked up in Q1, and then surged in Q2, before contracting again in Q3 (see chart).

Despite the steady rise in New Zealand’s two-year bond yield over most of 2021, NZD/USD retreated after reaching the 0.7465 March 2021 high, and began trending lower over the remainder of 2021. Global dairy prices fell from their March highs, and the USD began to strengthen in mid-2021. The USD began to rise as U.S. inflation pressures accelerated, and as markets started to factor in the prospect of a Fed tapering in late 2021, as well as a lift in the Fed funds rate in 2022.

New Zealand business sentiment also began to soften after New Zealand’s government introduced the most stringent level 4 covid-related lockdown restrictions in mid-August (see chart). Ironically, the Reserve Bank of New Zealand (RBNZ) announced that they would have raised interest rates if the government hadn’t introduced the level 4 lockdowns the day before their 18 August board meeting.

Following an easing of government restrictions, the RBNZ lifted interest rates 0.25% at each of their next two policy meetings. The 6 October policy meeting and the 24 November policy meeting, taking the official cash rate to 0.75%. The lift in interest rates was to reduce monetary stimulus, maintain price stability, and support maximum sustainable employment. NZD/USD fell after each of the policy meetings because market speculation had priced in larger interest rate rises than the 0.25% the RBNZ delivered on each occasion.

NZD/USD is a volatile exchange rate. Market participants may find it helpful to understand the reasons why NZD/USD is so volatile is because New Zealand is a small open economy, with commodities as the main export. The other reason NZD/USD is so volatile is because there is less liquidity in the New Zealand dollar exchange rate compared to the major exchange rates. NZD accounts for only 2.1% of global foreign exchange turnover, compared to 32.3% for the EUR, and 88.3% for the USD.      

NZD/USD over 2022 will continue to be driven by similar factors as it was in 2021. The path of the USD as the Fed prepares to lift interest rates, and the extent of further interest rate rises by the RBNZ are two notable events set to generate typical daily volatility in NZD/USD over 2022. 

PinPoint Macro Analytics


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