By Roger J Kerr
Instead of stabilising at the lower levels around 0.7500 / 0.7600 as anticipated, the NZ dollar has put in a stunning rebound performance to climb back above 0.8000 over this past week.
The Australian dollar led the NZD down from 0.8800 to 0.7500, and it has again been the Aussie dollar that is behind the five sent bounce back upwards.
It is too early to say whether the reversal in direction of the AUD against the USD (up from 0.9600 to $1.0350) is permanent in nature or merely profit-taking by speculators on the earlier plummet.
Certainly, global commodity prices have rebounded strongly over recent days as more confidence comes back into commodity and equity markets around the world in expectation that the European debt problems can be solved.
That high market expectation for European leaders are set to announce solutions at next Sunday’s summit meeting does appear to be more wishful thinking than reality. European Government and financial leaders have not found workable solutions to contain and reverse the sovereign debt crisis over the last 18 months, why would they suddenly have the miracle answers now?
The rest of the world have much more pressure on the Europeans to take action now, however the solution to high deficits and too much debt can never by anything else but years of austerity, lower Government spending and higher taxes.
The tax increases make economic growth harder to achieve, so the answer is always a slow, hard grind to recovery and debt reduction.
The lift in markets last week appears to have ignored the enormity of that sole solution.
The EUR/USD rate has also reversed from $1.3200 to $1.3800 as European hopes lifted and the international investor sentiment turned to 'risk-on' mode. Just how sustainable this more positive market sentiment is, is a debatable point.
It appears that the markets could be setting themselves up for major disappointment if they think that the European leaders are going to deliver all the solutions over the next two weeks. Nothing has changed with the lower global economic growth outlook, therefore this latest increase in commodity prices does not appears to have much substance behind it.
The Euro-zone economy is headed for much lower growth outcomes, potentially back into recession. Chinese inflation now appears to be in check, so no strong reasons for the People’s Bank of China to tighten monetary policy any further. Perhaps this change has given some renewed confidence to commodity markets.
NZD/USD direction
As always, the near-term direction of the NZD/USD exchange rate will depend heavily on the AUD/USD rate, the EUR/USD rate, global commodity prices and world equity market direction.
Given the impressive gains in all those lead indicators over the last week, it will take some spectacular new/fresh positive economic news to push them further higher.
It is difficult to see what that additional positive factor could be.
The balance of probability from here has to be general market disappointment at progress out of Europe and the NZ dollar giving back its recent gains.
Locally, the economic news has not been too favourable (apart from an impressive All Black’s victory over the Aussies to progress to the Rugby World Cup final).
Manufacturing performance has deteriorated and the Government’s finances have also deteriorated as the earthquake costs continue to increase.
Thin, illiquid NZD foreign exchange markets with many of the global investment bank players withdrawing from the market over recent weeks, is exaggerating intra-day and inter-day movements currently.
The chart below indicates that the Kiwi dollar should encounter major resistance at the 0.8150 area.
I do not expect it to get that high this week.
Chinese economic data in the form of industrial production and GDP figures tomorrow (Tuesday) will be the short-term focus of the currency markets. Any signs of weakening trends will s end commodity prices and the AUD lower.
USD exporters should now be holding off from further hedging activity after entering cover at the lower levels; importers need to be topping-up their hedging percentages (particularly in the 0-6 month bucket).
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* 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
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