Brian Gaynor 's Opinion

Brian Gaynor is a Weekend Herald columnist.

Brian Gaynor: Why everyone likes trading in our money

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We're only a small country, but NZ's dollar is the 10th most popular currency on foreign exchange markets

NZ's currency is likely to remain popular next year, especially if interest rates go up and dairying's prices and production stay firm. Photo / Mark Mitchell
NZ's currency is likely to remain popular next year, especially if interest rates go up and dairying's prices and production stay firm. Photo / Mark Mitchell

The latest Bank of International Settlements global foreign exchange turnover survey shows that the New Zealand dollar has maintained its place as the world's 10th most traded currency.

This is quite extraordinary when it is considered that we have a population of 4.5 million against an average of 260 million for the nine currencies ranked above us.

The 10 currencies ranked below us have an average population of 172 million.

Why is the NZ dollar such a heavily traded currency and what implications does this have for the year ahead?

The BIS survey, which is carried out every three years, reveals that the kiwi has moved from 0.2 per cent of global foreign exchange volume in 1998 to 2 per cent this year.

This is a rise from 17th to 10th position over the 15-year period.

Since 1998 the New Zealand dollar has passed the Swedish krona (now in 11th place), Russian rouble (12th), Hong Kong dollar (13th), Norwegian krone (14th), Singapore dollar (15th), South African rand (18th), Brazilian real (19th), Danish krone (21th) and Czech koruna (26th).

The nine currencies the kiwi has overtaken since 1998 have an average population of 48 million.

The other high-flying currencies since 1998 have been the euro, which has soared from 32nd to 2nd position, the Chinese renminbi from 30th to 9th and the Turkish lira from 33rd to 16th.

The latest BIS study, which assesses data for April this year, shows that the New Zealand dollar had an average turnover of US$105 billion a day.

This makes it New Zealand's largest financial instrument by a wide margin as non-repo NZ Government bonds had daily volume of $950 million during April and the New Zealand sharemarket $145 million.

Thus, the kiwi had 131 times more daily volume than the non-repo NZ Government bond market and was 855 times greater than the NZX.

As far as the global FX market is concerned, the BIS notes that there has been a significant increase in activity from US$3971 billion a day in 2010 to US$5345 billion a day.

The study says: "The role of the US dollar as the world's dominant currency remains unchallenged. FX deals with the US dollar on one side of the transaction represented 87 per cent of all deals initiated in April, about two percentage points higher than three years ago (total trades add up to 200 per cent because there are two sides to every transaction)".

In second place is the euro, which had a market share decline from 39.1 per cent in 2010 to 33.4 per cent this year. This drop was mainly due to the euro area sovereign debt crisis.

The next most traded currencies are the yen with a 23 per cent market share, pound sterling (11.8 per cent), Australian dollar (8.6 per cent), Swiss franc (5.2 per cent), Canadian dollar (4.6 per cent), Mexican peso (2.5 per cent), Chinese renminbi (2.2 per cent) and New Zealand dollar (2 per cent).

The Australian dollar has gone from 6th to 5th in terms of turnover since 1998 but is now only 4.3 times larger than the New Zealand dollar in terms of volume compared with 15 times in 1998.

No matter which way one looks at it, the growth in popularity of the kiwi over the past 15 years has been remarkable, particularly as emerging market currencies have had nine times volume growth since 2001 while developed world currencies have expanded only four fold.

On a global basis investment banks, hedge funds, pension funds, mutual funds and insurance companies are playing a much bigger role in FX markets, while trading by official financial institutions, such as central banks and sovereign wealth funds, accounted for less than 1 per cent of global FX market activity in April this year.

The Reserve Bank noted this month in its Bulletin article "Foreign exchange turnover: trends in New Zealand and abroad" that in the early stages of a country's development, FX turnover increases in line with trade-related activities.

But as the country develops, FX turnover increases at a faster rate than GDP growth because of the greater depth, complexity and openness of a country's financial markets.

The article says the New Zealand dollar "is more stable when FX volumes are high. A reason for this is that as turnover increases, liquidity also improves, in the sense that there are more buyers and sellers at every price point, and less currency movement for every given trade. By comparison, low volume periods in the New Zealand market are related to a material rise in NZD/USD volatility, possibly reflecting a lack of liquidity and unwillingness of market participants to transact".

New Zealand has always had a high FX turnover relative to GDP, although it has dramatically increased in recent years.

There are several reasons for this, including:

New Zealand has a low saving rate and, as a result, our interest rates are relatively high compared to other countries. Thus, the New Zealand dollar attracts international investors seeking yield. Many of our biggest companies, particularly banks, are overseas owned and their owners use FX swaps to reduce the foreign exchange risks associated with their New Zealand dollar assets. New Zealand organisations are big borrowers on international markets, and these loans have to be converted into New Zealand dollars.International trade is a large part of the New Zealand economy and exporters and importers are significant FX market participants. The New Zealand dollar probably attracts more than its fair share of speculative currency trading because we have open financial markets and the Reserve Bank of New Zealand doesn't have the financial resources to have a material influence on the kiwi's value.

But one of the more notable features of the kiwi is that it has the lowest percentage of its currency traded at home. In April, about 10 per cent of the total daily transactions of US$105 billion were conducted in New Zealand, the rest were done overseas.

Most trading in the NZD/USD, which is the New Zealand dollar's most important pair, takes place in overseas markets, particularly London. The London order book is generally deeper and the bid-offer spreads tend to be narrower as there are more participants in this market.

The future direction of the New Zealand dollar is extremely difficult to predict and most forecasters get it wrong, mainly because the kiwi overshoots on the high and low side.

For example, in October 2011 the Treasury forecast that the Trade Weighted Index - a measure of the value of the New Zealand dollar against the currencies of New Zealand's major trading partners - would be 70.1 in March 2013.

In December last year, it raised its TWI forecast for March this year to 73. The actual outcome was 75.9.

The TWI is now at 77.9 and the Treasury is forecasting it will be at 77 in March next year and 75.3 in March 2015.

The latest forecasts could be wrong again because the NZ dollar is unlikely to ease in the short term, particularly if the Reserve Bank raises interest rates next year and dairy volumes and prices remain firm.


Brian Gaynor is an executive director of Milford Asset Management.

- NZ Herald

Brian Gaynor

Brian Gaynor is a Weekend Herald columnist.

Brian Gaynor has written a weekly investment column for the Weekend Herald since April 1997. He has a particular particular passion for the NZX and its regulation. He has experienced - and suffered through - the non-regulated period prior to the establishment of the Securities Commission in 1978 and the Commission’s weak stewardship until it was replaced by the Financial Markets Authority (FMA) in 2011. He is also a Portfolio Manager at Milford Asset Management.

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