By Roger J Kerr
High expectations from the financial and investment markets around the globe that European summit meetings this week will deliver a comprehensive bail-out solution to Europe’s debt woes are behind the latest surge upwards in the NZ dollar value against the USD.
The investment markets have over recent days returned to full throttle risk-on mode ahead of the European announcements.
As a result, the NZD/USD rate has been propelled strongly upwards to 0.8100 from the 0.7800 / 0.7900 area.
The Kiwi dollar continues to follow the AUD/USD rate very closely, which in turn tracks global commodity and equity market fortunes.
The latest surge higher by the NZ dollar has very little to do with our own economic performance or outlook.
Over recent weeks the AUD has completed a spectacular reversal in fortunes from rates as low as 0.9400 against the USD to $1.0500 today, an 11 cent gain that has out-stripped the mirroring NZD gains from 0.7500 to 0.8100 - the consequence of which is a lower NZD against the AUD on the cross-rate from above 0.7900 to 0.7720.
Not all the AUD gains are directly related to market expectations that the European debt crisis will be resolved in short order. Metal and mining commodity prices have roared back up again as Performance of Manufacturing (PMI) index measures out of China have not deteriorated as much as many first feared. The copper price has reversed sharply upwards and the AUD/USD rate has a very high correlation to copper price movements, as copper demand, supply and thus price are a good proxy measure for Chinese economic growth performance.
The NZD/USD exchange rate is not expected to be influenced by upcoming local economic news or events. The NZ Government Treasury will be lowering their GDP growth forecasts in their pre-election economic and fiscal update this week. The September quarter’s inflation numbers will be of no surprise or consequence.
The RBNZ’s OCR review will come and go this Thursday with no change and accompanying comment from Governor Bollard that there is just too much uncertainty in the world to be adjusting monetary policy with any confidence. These aforementioned factors are not expected to impact on the NZD/USD direction in the short term as AUD and global market variables overpower and dominate.
It has to be said that there is massive room for disappointment this week if the Europeans fail to deliver a comprehensive debt bail out solution.
The Germans are resisting many of the proposals to gear up the EFSF or have the ECB play a more central role in the European debt restructuring. There is a lot of pressure on the European leaders to deliver a workable solution and reduce the risk of a major recession in the Euro-Zone economy. If they fail to meet the expectations, one could expect a sharp reversal in commodity and share markets as speculative positions are rapidly unwound.
It would be nice thought that the NZ dollar has gained those two cents over the long weekend due to the All Blacks winning the Rugby World Cup on Sunday night.
Certainly the nation’s spirits are lifted and the whole RWC event has been a fantastic showcase for all that is positive about New Zealand.
Unfortunately the “feel good” factor only plays a small part in the large capital and speculative flows that determine where the NZ dollar travels from day to day.
Outside the crazy daily volatility that has now become the norm for the NZ dollar market, the longer term prospects and conditions for the NZ dollar cannot be regarded as negative.
Should the lack of a credible solution in Europe lead to the European and US economies heading into recession again, the Kiwi dollar would certainly fall away again with commodity and equity markets. The probability of that scenario happening still remains about 25%, however the return to above 0.8000 in recent days appears overdone on the high market expectations.
Longer term, the positive economic fundamentals of New Zealand exporting protein to booming Asian economies have to be positive for the NZ dollar in a relative sense to the rest of the world. With our wagon firmly hitched to Australian and Chinese economic fortunes comes a major risk of the NZD becoming far too over-valued for our own good.
The risk of extreme over-valuation and our current policy of not doing anything about that were highlighted recently by the visiting chief investment strategist for Investec, Dr Michael Power (Investec being a sponsor for the RWC). Dr Power sees New Zealand potentially suffering from “Dutch Disease” of an export boom creating instantaneous wealth and excesses, as well as an over-valued currency that eventually wipes out the productive heartland of the economy. His view is that the NZ Government and central bank should not be so “hands-off” with the currency over-valuation and allow this economic destruction to occur without some policy response.
The RBNZ have to date used their currency intervention powers sparingly as they do not believe it makes any difference to the direction and exchange rate level. Investec control over USD100 billion of funds under management, therefore let’s hope the officials in Wellington were taking note of Dr Power’s views on our currency.
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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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