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New Zealand Dollar Outlook Darkens as Economy Slows

The Reserve Bank of New ZealandThe Reserve Bank of New Zealand

A leading global FX analyst expects New Zealand dollar to underperform over coming months as the economy experiences a sharp slowdown as a buildup of private debt finally catches up with rich asset prices.

New Zealanders have been steadily taking on debt over the course of the past ten years; a process that has contributed to eye-wateringly expensive real estate prices, poundsterlinglive.com reported.

But debt—or leverage—goes beyond just house prices, it is used to finance spending across the economy and is identified as a key driver of New Zealand’s recent economic outperformance relative to other developed-market economies.

The slowdown in New Zealand’s economy and growth in domestic debt pile comes at a time when global financial conditions are flourishing, with bond yields staying low relative to nominal GDP.

According to the Reserve Bank of New Zealand, in the 20 years to 2011, total housing and consumer loan debt increased around six-fold in dollar terms. As a ratio of household disposable income, the percentage at June 2011 of 147% is about two and a half times that of 58% at March 1991.

Globally, US households have started leveraging up again, following a trend that has been in place in other developed-market economies for some time.

Notably, Norway, Sweden, Canada, Australia and New Zealand have all increased their private sector leverage since the collapse of Lehman Brothers. In many cases, local bank balance sheets have also grown.

“With ambitious asset valuations in place, these economies may be the start of the next global economic slowdown,” says Hans Redeker, Strategist with Morgan Stanley. Redeker believes two scenarios could play out within these leveraged economies:

1) Leverage may reach its natural limits, slowing economic activity.

2) Rising global funding costs may increase debt maintenance costs, causing outperforming economies to underperform.

“Over the course of the coming quarters, these economies’ growth may slow,” says Redeker.

Importantly, Morgan Stanley warns foreign exchange markets have not considered the likely outcome of New Zealand’s debt problem, therefore the risks of a sizeable adjustment lower in the New Zealand dollar might occur should Redeker be right.

“Instead, NOK, SEK, CAD, AUD and NZD have been strong,” says Redeker, “providing us with strategic selling opportunities later this year.”

Morgan Stanley refer to the sample of over-leveraged developed-market economies as the ‘canaries in the coal mine’.

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