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EUR/NZD Could Strengthen On The Back Of COVID-19 Risks And A Stronger Real Yield

EUR/NZD has been consolidating over the past few weeks. The euro remains stronger against the U.S.

Tourism is a significant component of NZ GDP and employment. As a second wave of COVID-19 drags on, the NZ economy is likely to struggle.

However, while EUR has found appeal as an even closer competitor to USD (as a world reserve currency), NZD is exposed to plenty of risks.

dollar this year, as does the New Zealand dollar.

The EUR/NZD currency pair, which expresses the value of the euro in terms of the New Zealand dollar, remains both above levels that were last seen at the start of 2020 (“pre-COVID-19”) and below the heights of March 2020 (the month in which equities were at their lows after crashing in Q1 2020).

The euro has strengthened significantly against the U.S. dollar this year, owing to significant monetary interventions that have seen USD rates collapse to the zero lower bound. Both EUR and NZD have benefited from lower oil prices too, since both the euro area and New Zealand are net importers of crude oil products.

It is prudent to always check whether a currency pair is correlated to risk assets. One of the best barometers of global risk appetite is the U.S. equity market, given its historical outperformance globally and the popularity as evidenced by international capital flows. (As indicated by U.S. Treasury data, foreigners made net purchases of U.S. equities every month except April, between January and July 2020; a total net inflow of almost $140 billion.)

The chart below illustrates the generally negative relationship between EUR/NZD (the black line) and S&P 500 futures prices (the red line).

(Source: TradingView. The same applies to price charts presented hereafter.)

Occasionally these instruments are aligned positively, but usually only for brief periods. The euro tends to strengthen against other currencies when it is also strengthening against the U.S. dollar. When USD is weakening, U.S. risk assets become more attractive in international FX terms, and thus a stronger euro is usually associated with risk-on activity.

There are, of course, exceptions to this – a stark example being earlier this year (March 2020), when EUR spiked as global equities sold off. This was a mechanical move owing to capital repatriation as short-EUR carry trades were unwound, while U.S. interest rate cuts sedimented the euro’s stronger position.

However, excluding these exceptional one-off adjustments, usually the euro will correlated positively with risk asset prices, and even gold prices (since commodities such as gold are principally denominated in U.S. dollars). This also applies to risk-on commodities like oil, although oil is known to have a life of its own, with its own unique sources of volatility (including geopolitics).

NZD is considered a risk-on currency owing to New Zealand’s smaller, less-sophisticated economy which often tries to support its export industries to support a stronger current account (and by extension, its domestic GDP growth and employment rate). Because of the smaller size of the NZD market, relative to other more liquid currencies such as USD, EUR and JPY, risk-on and risk-off moves usually create relatively stronger moves in NZD (i.e., the smaller the market by volume, the more market moves tend to find amplification).

Tourism is also important for New Zealand, more so than other countries. It is difficult to truly quantify the total (direct and indirect) dependence of a country’s GDP on inbound tourism (net of outbound tourism), but the COVID-19 pandemic has disproportionately affected New Zealand relative to most other countries around the world. This is to compare New Zealand to major European and American countries. Around 20% of jobs in New Zealand are thought to be built on the tourism industry.

If we look to terms of trade (the ratio between a country’s export and import prices), both German (a nation serving as a proxy for the euro area) and New Zealand terms of trade are higher on the year. In fact, New Zealand terms of trade appears to have benefited more so than German terms of trade. Yet, given the dependence that New Zealand has on the tourism industry, the real effects of the current crisis are probably yet to truly manifest in the macroeconomic indicators (including…

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