NZD/USD Forex Trading Strategy

NZD/USD Forex Trading Strategy

This article will cover the following

  • Overview of New Zealand’s economy
  • Overview of the US economy
  • Properties of the NZD/USD cross
  • Average spread, volatility, correlation to other pairs
  • Trading strategies
  • and more

According to the Triennial Central Bank Survey by the Bank for International Settlements (BIS), the currency composition of global Forex trading has been notably shifted during the period 2010-2013. The US dollar remains the world’s major reserve currency, which stood on one side of 87% of all trades in the Forex market as of April 2013. Among the most actively traded advanced economy currencies, the New Zealand dollar, alongside its Australian counterpart, continued to expand its presence in global Forex trading. The New Zealand dollar has increased its share in global currency trading from 1.6% in 2010 to 2% as of April 2013, which ranked it 10th. At the same time, NZD/USD accounted for 1.5% of the total turnover in April 2013, which ranked the pair 9th.

Economy of New Zealand and major economic indicators

new zealand flagAccording to the International Monetary Fund, in 2013 New Zealand is ranked 54th in terms of its nominal Gross Domestic Product of $181.574 billion, and 69th in terms of its GDP based on purchasing power parity (PPP). It is a market economy greatly dependent on international trade. Because of its small territory and the huge distances from major world economies, the country is faced with challenges on the international scene. Being New Zealand’s nearest neighbor, Australia plays a key role in trading relations.

According to Statistics New Zealand, in 2013 trade between New Zealand and Australia was estimated to NZ$25.6 billion, with 19% of New Zealand’s exports, including light crude oil, gold, wine, cheese and timber, being oriented towards Australia. China is New Zealand’s second largest trading partner, with trade between the two nations being estimated to NZ$16.8 billion. This figure is the result of increasing demand for imported dairy products, especially after the Chinese milk scandal in 2008. Chinese demand for milk products has been quite strong in the past years, which also led to a 51% surge in total exports namely to China during the twelve months to March 2014.

The agricultural, horticultural, forestry, mining and fishing industries play a crucial role in New Zealand’s economy, particularly in the export sector and in employment. Agriculture accounted for around 4.0% of the GDP in 2012, while the processing of food, beverage and tobacco products contributed to a further 5.0%.

Service industries comprise a large proportion of the nation’s economy, accounting for more than two-thirds of its GDP. The sector of services registered consistent growth between 2000 and 2007, with annual growth rate averaging 3.9%.

Tourism is one of the largest single sources of foreign-exchange revenue and also a key growth industry in New Zealand. During the year to March 2012, international tourist expenditure was at the amount of $9.6 billion, or an increase by 1.6% compared with the prior year.

The stock of foreign direct investment in New Zealand amounted to $97.3 billion as of March 31st 2012, with Australia and the United States being the largest contributors to total foreign direct investment in the country. US investments were worth $54.4 billion, while Australian investments – $10.6 billion.

Economic indicators

Here we provide a list of macroeconomic indicators, which tend to cause the largest influence on New Zealand’s dollar on the global markets.

monetary_policyReserve Bank of New Zealand decision on policy. Established in 1934, the Reserve Bank of New Zealand (RBNZ) is New Zealand’s central bank. Although not a government department, it has been entirely owned by the government of New Zealand since 1936. The central bank has three major functions: 1. to operate monetary policy in order to maintain price stability; 2. to promote the maintenance of a sound and efficient financial system; 3. to meet the currency needs of the public. These functions are specified in the Reserve Bank Act 1989, which also gives the Reserve Bank statutory independence to carry them out. Price stability is defined by a Policy Targets Agreement, which at the time of writing required the Bank to keep consumer price inflation between 1% and 3% on average in the medium term, with a focus on keeping future average inflation near the 2% target midpoint. In order to implement monetary policy, the RBNZ sets the Official Cash Rate (OCR), which is reviewed eight times per year. The OCR was introduced back in March 1999 at a level of 4.50%. Its all-time low (2.50%) was registered at RBNZ’s policy meeting on April 30th 2009, while its all-time high (8.25%) was reached at the policy meeting on July 26th 2007. Since the beginning of 2014 the central bank has introduced four consecutive rate hikes from a level of 2.50% to the current level of 3.50%. The most recent interest rate increase occurred at the bank’s policy meeting on July 24th.

Gross Domestic Product. The sector of services comprise the largest portion of New Zealand’s Gross Domestic Product, almost 75%. Within services there are several key segments – finance, insurance and business services, which account for 30% of the entire GDP; personal and community services with a share of 13% and transport and communication with a share of 11%. Industrial sector contributes to 17% of the nation’s GDP. Within this sector, manufacturing accounts for 13% of the GDP, while construction – 4%. The remaining 8% of the economy is comprised by agriculture, fishing, forestry and mining. Within the period 1988-2014 New Zealand’s Gross Domestic Product expanded at an all-time high annual rate of 7.30% during the third quarter of 1993 and at an all-time low annual rate of -3.40% during Q1 2009. New Zealand economy registered an annual growth rate of 3.8% in the first quarter of 2014, a 3.9% growth in the second quarter and a 3.2% growth in the third quarter.

Consumer Price Index. The Consumer Price Index (CPI) provides information about changes to the prices of consumer items, which New Zealand households purchase, and is also a measure of consumer inflation. In New Zealand 11 groups of items comprise the CPI: food, housing and household utilities, health, recreation and culture, education, communication, clothing and footwear, transport, alcoholic beverages and tobacco, household contents and services, and miscellaneous goods and services. Within the period 1918-2014 the nation’s annualized inflation recorded an all-time high of 44% in the third quarter of 1918, while marking an all-time low of -15.30% in Q1 1923. In 2014 annualized inflation was reported at 1.5% in the first quarter, 1.6% in the second quarter and 1.0% in Q3. The latter has been the lowest annual rate since Q2 2013, when the CPI rose 0.7%.

Producer Price Index. Producer prices reflect the performance of private sector entities in New Zealand, a closely watched indicator by the Reserve Bank of New Zealand. There are two indexes to measure prices – the Input Producer Price Index, which measures the cost of items business entities purchase, and the Output Producer Price Index, which measures the prices private sector entities receive for their goods and services.

Within the period 2007-2014 the Input Producer Price Index in New Zealand marked the largest quarterly increase of 5.6% during the second quarter of 2008 and the largest quarterly decline of 2.5% during the first quarter of 2009. In Q3 2014 the Input PPI fell 1.5% on a quarterly basis, or the most since Q1 2009. The PPI dropped at a quarterly rate of 1.0% in Q2 2014, neutralizing the 1.0% gain, recorded in Q1.

Within the period 2007-2014 the Output Producer Price Index in New Zealand marked the largest quarterly increase of 3.5% during the second quarter of 2008 and the largest quarterly decline of 1.4% during the first quarter of 2009. In Q3 2014 the Output PPI dropped 1.1% on a quarterly basis, or the most since Q3 2009. The PPI fell at a quarterly rate of 0.5% in Q2 2014, following a 0.9% gain in Q1.

Change in employment. The Household Labour Force Survey presents data in regard to the number of people employed, unemployed, and not in the labour force, actual and usual hours worked and the number of people in occupations and industries. The employment change, as an indicator, reflects the change in the number of people in paid employment. It has a direct link to consumer spending and respectively, to overall growth. Within the period 1986-2014 employment in New Zealand rose at the highest quarterly rate of 1.67% during the fourth quarter of 2004 and marked the largest quarterly decrease of 1.72% during Q1 2009. In Q3 2014 the number of people employed increased by 18 000, or 0.8% compared to Q2, to reach the seasonally adjusted 2 346 000. The number of unemployed persons was recorded at 134 000 in Q3, or a 2.8% drop on a quarterly basis, which led to a jobless rate of 5.4%.

In Q2 2014 the number of people employed rose by 10 000, or at a quarterly rate of 0.4%, the lowest since Q1 2013, to reach the seasonally adjusted 2 328 000. The number of unemployed persons was registered at 137 000 in Q2, or a 6.3% decline on a quarterly basis, which drove the rate of unemployment to 5.6%.

In Q1 2014 the number of people employed rose by 22 000, or 0.9% compared to the last quarter of 2013, to the seasonally adjusted 2 318 000. The number of people looking for employment was unchanged at 147 000 in Q1, while the rate of unemployment was also steady at 6.0%.

Balance of trade. As we already said, New Zealand’s economy is dependent on international trade. The country’s main exports include meat, dairy products, forest products, fruit and vegetables, fish, and wool, while its main imports – machinery and equipment, vehicles and aircraft, petroleum, electronics, textiles and plastics. Within the period 1951-2014 the nation had the largest trade deficit in September, which amounted to NZD 1.350 billion, while its largest trade surplus was recorded in April 2011, estimated to NZD 1.157 billion. In 2014 New Zealand had six consecutive months of surpluses starting January and four consecutive months of deficits starting July. The last deficit figure (in October) was at the amount of NZD 0.908 billion. It has been the largest October deficit since 2008, as exports to China marked a sudden drop, while imports of capital goods expanded.

Economy of the United States and major economic indicators

us flagThe United States is the world’s largest economic power with a nominal Gross Domestic Product (GDP) at the amount of $16.8 trillion in 2013. It represents almost 25% of the global nominal GDP. It is also the world’s second-largest trading nation, following China.

The US economy is primarily service-oriented, as almost 80% of the GDP is produced by sectors such as real estate, transportation, financial services, other business services and health care.

The country is the second largest manufacturer in the world with an industrial production of $2.43 trillion during 2013, or larger than the output of Germany, France, India and Brazil combined. Major industries are petroleum, steel, automobile production, aerospace, construction and agricultural machinery, chemicals, electronics, telecommunications.

Moreover, as of 2013 the United States is the third-largest producer of oil (8 453 000 barrels per day, or 9.97% of the global total oil production) and the largest natural gas producer (66.5 billion cubic feet per day).

Taking into account the sheer size of the US economy and its pillars of strength, one can clearly understand the effect of economic data from those sectors on the US dollar, and in turn on the global Forex market. After all, the greenback stands on one side of 87% of all trades, according to the BIS.

Economic indicators

Here we provide a list of macroeconomic indicators, which tend to cause the largest influence on the United States’ dollar on the global markets.

– Non-farm payrolls

– Consumer Price Index

– Producer Price Index

– Trade Balance

– ISM Non-manufacturing

– ISM Manufacturing

– Federal Reserve Minutes

– Consumer Confidence (released by the Conference Board research group and Thomson Reuters/University of Michigan)

– Retail Sales

– Industrial Production

More details on these indicators you can find in our article “Profile of United States’ dollar”.

Properties of the NZD/USD cross

Average spread

Depending on the Forex broker used, the spread can be fixed, floating, or both. For the purpose of this article, we have chosen the average spreads provided by 10 brokers, namely Saxo Bank, Dukascopy, Alpari UK, XM, Forex.com, FxPro, Markets.com, eToro, FXCM and Iron FX, and aggregated all the spread data provided to a single average spread, in the NZD/USD case – 3.11 pips.

Relative performance against other pairs

Muscles-iconWe conducted a series of calculations to gauge the performance of the NZD/USD pair relative to other crosses, which include the US dollar over a certain period of time. For details about the calculation’s variables, visit the appendix.

Let us look at Table 1, which reflects the strength of the US dollar against a number of currencies. EUR/USD registered a prominent high on May 8th 2014 at 1.3993, respectively this has been a prominent low for the US dollar against the euro. In the case with EUR/USD we inverted the result, so that it represents the change from the US dollar’s point of view (which means that the figure would actually represent the USD/EUR’s movement). The same is valid for GBP/USD, NZD/USD and AUD/USD. For each pair in the table we used the low price on May 8th and the closing price on December 31st. The US dollar gained the most against the Russian ruble, showed almost no change against its Hong Kong counterpart and lost ground against the Chinese yuan only.

On the basis of results in Table 1, we move on to rank each of the 22 currencies. As can be seen from Table 1.1, the Chinese yuan has been the strongest currency, followed by the US dollar, the New Zealand dollar has been ranked 9th, the euro – 14th, while the ruble has been the worst performer among this particular list of currencies. The New Zealand dollar has lost 9.862% against the US dollar, the euro has plunged 13.521%, while the ruble has depreciated 70.913% during the examined period.

Correlations to other pairs

arrows_correlationThe term “correlation” refers to the connection between two assets and how they move in relation to each other. As a key component of advanced portfolio management, correlation is crucial for achieving maximized risk-adjusted return. Ranging between -1 and +1, a correlation close to the upper limit means that the two currencies are moving in almost perfect consonance, allowing for almost no diversification, and vice versa. A correlation of 0, which in the world of finance practically does not exist, means that movement of the two assets is completely random.

Below you can see two tables, which present those currency pairs that demonstrate the strongest positive correlations relative to NZD/USD and those crosses, showing the strongest negative correlations. The statistics are derived from daily market data, encompassing 300 periods (trading days), or approximately the whole year 2014.

Top 5 positive correlations
GBP/USD 0.94
EUR/USD 0.91
AUD/USD 0.91
AUD/CAD 0.84
EUR/CHF 0.72
Top 5 negative correlations
USD/CHF -0.92
USD/DKK -0.91
USD/JPY -0.86
USD/CAD -0.86
USD/SGD -0.86

Volatility

The term “volatility” in Forex refers to the fluctuations a currency pair exhibits during trading. These fluctuations directly impact the amount of risk a trader is subjected to, but also his return. A higher volatility means that the currency pair could potentially perform a sudden and drastic move in either direction over a short period of time.

In contrast, low volatility implies that the exchange rate does not have the potential for wide fluctuations and instead moves at a steady pace over a longer period of time. Lower volatility carries less risk for market participants, but it is also much harder to profit from, especially by shorter-term traders such as scalpers and day traders.

For the purpose of this article, we have selected to display historic volatility calculated over the last 52 weeks, or the period between January 1st 2014 and December 31st 2014. In order to measure historic volatility of each currency pair on our list, we use two methods similar to the Average True Range:

Intraday Volatility (%) = {(Intraday High – Intraday Low) / Intraday Low}%

and

Daily Volatility (%) = {(Current Daily High – Previous Daily Low) / Previous Daily Low}%.

Below are the results in regard to NZD/USD during the examined period.

Day High Low Intraday Vol. Daily Vol.
Dec 31, 2014 0.7855 0.7779 0.977% 1.120%
Dec 30, 2014 0.7851 0.7768 1.068% 1.421%
Jan 02, 2014 0.8234 0.8137 1.192% 0.574%
Jan 01, 2014 0.8224 0.8187 0.452% 0.342%
Average for the year 0.828% 0.812%

As can be seen from the table, NZD/USD showed an average intraday volatility of 0.828% during the past 52 weeks, while the pair’s average day-to-day volatility was 0.812%. During the examined period the pair tended to show a higher volatility in comparison with other majors such as EUR/USD, for instance. Table 4 in the appendix presents generalized data regarding the average annual volatility, shown by the seven major pairs in 2014.

At the beginning of the year the pair tended to have the most significant daily volatility. In late January and early February the cross showed daily moves of about 85-90 pips. As the year progressed, the daily volatility decreased, as in June and July the pair showed daily moves of under 80 pips. The lowest daily volatility (about 65-70 pips) was registered in late August.

Within a trading day the highest volatility was registered between 12:00 and 15:00 GMT (20-25 pips per hour). The lowest volatility during the trading day was recorded between 4:00 and 5:00 GMT (under 15 pips per hour).

Within a trading week the pair tended to show the highest volatility on Wednesday (about 85 pips) and the lowest volatility on Monday (about 65 pips).

Carry trade

Variable Interest RateCarry trades are one of the most popular trading strategies used in the Forex market. When performing a carry trade, a trader typically sells a currency with a relatively low interest rate, while purchasing a higher-yielding one. The objective is to profit from the difference in interest rates, which can be substantial, especially when taking into account leverage. To learn more about carry trades, please read our article “Using Carry Trades to Maximize Profit“.

At present, the NZD/USD pair provides excellent carry trade opportunities. As we already said, the Official Cash Rate in New Zealand is currently maintained at 3.50%. The Reserve Bank of New Zealand has signaled a gradual rate increases in the future, as inflation rate in the country remains below the 2% target mid-point. However, it is expected to accelerate slowly in an intermediate term.

On the other hand, the Federal Reserve Bank has kept its benchmark rate within the range of 0%-0.25% at the past 47 consecutive meetings. The Fed has committed to begin raising borrowing costs in 2015, having already concluded its Quantitative Easing program. As long as this difference between interest rates in the United States and New Zealand is in place, NZD/USD may be used in carry trades. In the future such opportunities will depend on the policies followed by the two financial institutions – the timing and the pace of possible rate hikes.

Let us provide an example. With the help of a standard carry trade calculator we can conclude that if we were in a long position in NZD/USD with a standard lot and a holding period of 30 days, this would earn us $267.12 in interest. The respective earnings would be $26.71, if we held 1 mini lot, and $2.67, if we held 1 micro lot. For the sake of comparison, if we went long the USD/JPY pair with the same amount and holding period, this would earn us $10.23. The respective earnings would be $1.02, if we held 1 mini lot, and $0.10, if we held 1 micro lot.

Trading strategies

chess-strategyHighest trading volumes and volatility can be expected during the Asian and the US trading sessions, and more particularly when key economic indicators are released. It is logical to expect that the most intense trading will occur at the release of economic reports such as the US non-farm payrolls, US consumer sentiment and spending, US or New Zealand’s manufacturing activity growth, US durable goods orders, US or New Zealand’s consumer inflation, US retail sales, US or New Zealand’s balance of trade, US industrial/manufacturing production, New Zealand’s Producer Price Index, New Zealand’s Commodity Price Index, and last but not least, policy decisions by the Federal Reserve or the Reserve Bank of New Zealand. NZD/USD may also be influenced by key macroeconomic reports or political events taking place in Australia and China, New Zealand’s first two largest export markets.

Trading the fundamentals

Trading the major economic releases and other events without the help of technical analysis is basically done using three general strategies – using a proactive, a reactive or a mixed approach. Proactive trading suggests entering a position ahead of the release of the data and basing your decision on analysts’ forecasts, while the reactive approach implies entering the market after the data is published. Logically, a mixed approach combines the previous two. To learn more about these styles of fundamental trading, read our articles “Trading the News – Proactive Approach“, “Trading the News – Reactive Approach” and “Trading the News – Combining the Proactive and the Reactive Approaches“.

Technical trading

Let us have a look at a simple trading system, which utilizes the Average Directional Index and a set of Exponential Moving Averages. You can check it out here.