New Zealand Adds Yuan to Key Index Reducing USD Exposure. This is Why You Should Care

The reshuffle of the Trade Weighted Index reflects New Zealand's bilateral trading partnership with China, along with a broader trend

Following up on an October announcement, the Reserve Bank of New Zealand (RBNZ) is making changes to the components of its Trade Weighted Index, or better known as the New Zealand Dollar Index. As of tomorrow, Wednesday the 17th, the total amount of currencies in the index rises from 5 to 17, with their allocation reflecting New Zealand’s major bilateral trade partners.

yuanOf the currencies being added, the most impacting is the Chinese yuan, which will hold a 20.09% weighting, slightly below the Australian dollar’s 21.98% figure at the top of list allocations. Following the inclusion of the yuan, as well as other APAC related currencies, the weighting of the US dollar in the index drops to 12.34% from 31.71%, while the euro’s allocation falls to 10.87% from 26.85%.

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According to the RBNZ, the rationale for changing components of the index is due to trade involved in the countries of the initial five currencies (AUD, JPY, USD, GBP and EUR) declining to below 50% of New Zealand’s bilateral trade. Taking their place are Asian trade partners, of which China has become the largest, followed by Singapore and South Korea.

Why Should You Care?

For traders, the changes affect money flows that mimic the moves of the New Zealand Dollar Index as well as derivatives and structured products linked to the index. Although the index is relatively small in terms of overall funds tracking it, the change is part of a larger trend of central banks and governments to divest themselves from US dollar and euro exposure, in favor of other trade partners, which has a direct effect on currency valuations and volatility.

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Beyond price indexes, commodity pricing is probably the most influential place where denomination changes are impacting the market. With the majority of exchange-based commodity trading being priced in US dollars, global demands have led to more products being launched in alternative currencies. For producers, this provides benefits as they can sell and hedge their commodity production in their local currency.

Currently, most cross-denomination futures products have focused on regional commodities like Malaysian palm oil or Australian wheat, where there is a natural demand from growers for local currency-based financial products. Where things become much more interesting is in relation to crude oil, which has seen a dramatic fall in prices from over $90 at the end of September to a current $55 per barrel.

As a result of a 1970’s pact between the US and Saudi Arabia, and then taken up by OPEC nations, crude oil sales officially became denominated in dollars, best known as the petrodollar. Depending on one’s view of politics and conspiracies, the petrodollar, and the flood of US dollars being held by oil producing nations has been attributed to stock market bubbles and bursts, the global financial crisis, and the Middle East and North Africa wars and rulership changes.

In terms of the present, increased bilateral trade not involving the US means that there is greater incentive for oil producers to trade in non-dollar denominated crude oil products. This is already taking place, specifically between China and Russia, but major exchanges have yet to launch any deliverable crude oil future contracts (non-deliverable euro-denominated futures do exist).

Returning to the RBNZ, the emergence of central banks changing their index weightings sets precedents which can be relevant to evolving denominations of other financial products, with a larger result of affecting money flows and currency volatility.

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