The NZD (New Zealand’s currency) is strongly related to the AUD. This correlation stems from the fact that Australia is the major trading partner of New Zealand.
The latter’s economy is characterized as being trade oriented. This, combined with the fact that both countries are close to one another, leads to the strong relationship between them.
This means that if the Australian economy experiences an upturn, imports coming from New Zealand will increase.
Another characteristic of the NZD is its correlation with commodities. This trait stems from New Zealand’s export driven economy, leading to a 50% positive correlation with the prices of commodities. As a result an increase in the prices of commodities results in an increase in the value of the NZD.
Additionally, the Australian economy is also linked to commodity prices. As a result, when the prices of commodities increase the AUD appreciates as well. When this happens, the economic activity in the country betters, which in turn leads to increased trading activity with its major partner, namely New Zealand.
Because of the fact that both New Zealand’s economy and its major trading partner’s economy are commodity linked, the country is sensitive to any changes in the weather conditions, which may have a negative effect on its farming activities. For example, in the past severe draughts have cost the country millions of dollars.
The NZD benefits from one of the highest interest rates among industrialized countries. This makes the currency a preferred tool for the execution of carry trades.
The latter represents the selling or borrowing of a currency that has a lower interest rate and the purchasing or borrowing of a currency that has high interest rate.
Since investors look for currencies that generate high yields, the popularity of the NZD has increased among carry traders.
However, the NZD may lose its winning position if the global central banks attempt to increase their interest rates. As a result the positive interest rate differential between the NZD and the other currencies will decrease.
When carry traders start to close their positions, the NZD will experience a decline in its value.
Forex participants pay special attention to the interest rate differentials between the cash rates of the NZD and the short term interest rate yields of other industrialized countries’ currencies.
The reason for this is that these differentials give information on the potential money flows and the premium yield the NZD short term fixed income assets offer over foreign short term fixed income assets.
Additionally, since investors are looking for assets with high yields, differentials serve as a gauge for any potential movements in the value of the NZD.
The positive interest rate differentials between global fixed income assets represent the indicators that play a major role in determining the entering or exiting of a position by carry traders.