By Roger J Kerr
The New Zealand dollar has been classified in almost the same class as gold and the Swiss France as a “safe port in a storm” as global investors seek to protect their money from the US and European debt crises. The NZD/USD exchange rate has soared to new post-float record highs of 0.8800 as the demand for alternative currencies away from the USD and Euro has intensified over recent weeks.
Currency speculators have ridden on the backs of the investors parking their funds away from the USD and Euro. The Australian and New Zealand dollars are seen as safe currencies linked to the growth success of Asia. The big question for the forex markets in the short-term is how and when all the hedges against the USD put in place whilst the crisis raged, are unwound when the US politicians reach a compromise deal sometime in the next two days.
The markets still expect a USD recovery when the deal is agreed. The risk is that the deal appears like a patch-over job instead of a long-term permanent changes to US Government spending and taxes. There is dismay and annoyance outside the US that this US Government deficit/debt situation could have been allowed to develop into a major crisis that has caused so much anxiety, uncertainty and volatility in financial and investment markets globally.
However, there has to be an understanding of the US political situation of the hard-line Republican “Tea Party” members coming into Government last year to end the continuing growth in deficits and debt. It is said they have manufactured the crisis and taken it to the 11th hour to gain publicity for their cause. Unfortunately, they may have pushed too far and caused damage to the US’s international reputation in doing so. Where this leaves the US dollar value is really dependent on whether the currency markets see the inevitable debt deal as creditable and sustainable. There will certainly be relief that a debt default and credit rating downgrade has been avoided.
The economic and sovereign debt news out of Europe continues to deteriorate with the Euro only holding its ground against the US due to US debt problem. Once the compromise is announced on the US debt ceiling deal, the USD can be expected to make strong gains from $1.4400 against the Euro to below $1.4000. Italian Government bond spreads have blown out to their highest level in 12 years following their latest bond auction. German economic data is no longer as positive as it was a few months ago, thus the ECB is not expected to touch their interest rates for some time. A recoil of the USD should lead to massive unwinding of all the international funds parked in the NZD over recent weeks. The dramatic gains from 0.8300 to 0.8800 could and should be reversed as rapidly as they occurred.
New Zealand has become a victim of its own success with the previous high export commodity prices (particularly dairy) and stronger GDP growth numbers making us standout as a positive in a world of negatives (European and US debt woes). The Reserve Bank are in a very difficult position with monetary policy management, the super high dollar really preventing interest rate increases at this time outside the removal of the 0.50% OCR cut put in place in March after the Christchurch earthquake.
Last week’s OCR review statement correctly identifying the drag the high exchange rate will have on 2012 economic growth. Previous growth rate forecasts of 4.50% to 5.00% for 2012 are right out the window now as exporters are unprofitable and they cut back expansion/investment plans. The NZD currency value has a huge impact on overall economic performance and the RBNZ are well aware of this. Added to the seriousness of the situation is the fact international commodity prices for dairy and forestry are now correcting sharply downwards.
Normally, the NZD/USD rate would have followed commodity prices lower; however this linkage has been broken over recent weeks as funds flooded into the NZD as a safe haven from the USD and EUR. Once the US debt problem is resolved and the USD strengthens, the NZD has a lot of catching up to do against falling commodity prices. Dairy prices are expected to be down again at this week’s Fonterra GDT on-line auction.
Like the RBNZ, the Reserve Bank of Australia (“RBA”) also has a real dilemma on their hands with high inflation, however a weaker domestic economy. On balance, the RBA cannot increase their interest rates whilst their non-resources export sector and retail/housing sectors are struggling so much. The spectre of direct currency market intervention by either the RBA or RBNZ to reverse the respective currencies upward momentum cannot be entirely ruled out, even though all four of the pre-requisite criteria for intervention here in New Zealand are not fulfilled at this juncture.
If the NZD currency remains high in the 0.8000’s over coming weeks whilst our export commodity prices slide lower, the RBNZ should be seriously considering intervention. The Trade Weighted Index (“TWI”) is currently at 74.80, the TWI was at 75.00 when the RBNZ last intervened by selling NZD’s in 2007. The RBNZ should wait for the unwinding of US debt crisis hedges and then add to the selling to send the Kiwi tumbling. They need to pick their moment wisely in the foreign exchange marketplace to be effective with intervention. That moment may be in the next few days.
* Roger J Kerr runs Asia Pacific Risk Management. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com