One of the simplest ways to measure macroeconomic risk is to look at the twin deficit, defined as the sum of current account and budget deficit as a percentage of GDP. Recent blow-ups like Iceland and Greece both scored highest on these fronts. Looking at twin deficits gives a reliable indicator of the individual risk profile for a country in the context of a sudden spike in international funding costs or deleveraging. On the latest reading, New Zealand and Turkey stand out (apart from the usual suspects, ie eurozone periphery and South Africa), with twin deficits well in excess of 10% for both economies.
Interestingly, the US scores as a high risk economy as well mainly due to a very high budget deficit. This puts the US dollar structurally at risk. However, the US has benefited from being the world’s reserve currency, making it unlikely the US will be faced with the same sources of vulnerability as other economies in the short run.
New Zealand in particular looks vulnerable to us.
Foreign holdings of NZ government bonds are a good indicator of currency strength and recently a divergence has emerged as foreign holdings have declined even as the currency has remained strong.
The trade weighted index is at an all-time high and based on mean reversion alone, the currency looks vulnerable.
Furthermore, as Australia slows down, the risks to the Australian banking system, which is heavily geared to the domestic economy (mainly property) will grow. As New Zealand’s main banks are Australian owned, this has direct, financial-contagion risks to the New Zealand economy and thus the currency. We will write more on this in the April monthly.
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