CAD/NZD set to fall further - AmpGFX

Greg Gibbs, Director at Amplifying Global FX Capital, suggests that if the two key factors that account for a recovery in AUD/NZD are relative commodity prices and higher global yields, then we might also expect the NZD/CAD cross to fall.

Key Quotes

“The potential downside for NZD/CAD might be even more significant considering that CAD is a more pure energy play, and CAD is a relatively low yielder and is likely to be much less influenced by a ‘search for yield’ and, therefore, a recovery in global bond yields.

Fair-value model for CAD/NZD

We wouldn’t expect to be able to achieve as tight a relationship in the NZD/CAD to variables such as relative commodity prices and yield spreads as we do with AUD/NZD.  The Australian and New Zealand economies are much more closely interconnected by trade, finance, and immigration.  In the same way that Canada and the USA are related.  Other factors come into play, including broad developments in the USD and the US economy, in determining the direction on NZD/CAD.  And in general, we would expect more random noise.

Nevertheless, we conducted the same multiple regression analysis on NZD/CAD; using the 2-year swap rate spread, and relative commodity prices (over a medium term period of weekly observations). And over a shorter period of daily observations adding in the JP Morgan global yield index.  The latter model attempts to capture the extra demand generated by the ‘search for yield’ in an extreme low global yield environment.

It sends a similar message to the AUD/NZD analysis.  Without a global yield proxy for a ‘search for yield’ the NZD/CAD appears to be significantly over-valued, more-so than AUD/NZD was under-valued.  In the NZD/CAD instance, it is over-valued by 9.25 figures (2.8 standard errors).  This is consistent with the notion that CAD is further down the totem-poll in that ‘search for yield’ than the AUD.

Note that for a relative commodity price index we have used milk futures in New Zealand relative to oil price futures in the USA.  As such, we have picked up the most recent decline in milk prices in this analysis.

Incorporating a global yield proxy, NZD/CAD still appears overvalued, but by a lesser amount.  This time by 3.6 figures (although this still represents 2.3 standard errors in this shorter term model).”