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Roger J Kerr expects the AUD to fall below parity with the USD and the NZD will fall with it. Your view?

Posted in Currencies

 By Roger J Kerr

The dominating influence over the day-to-day NZD/USD exchange rate direction continues to be the movements in the AUD/USD rate.

The two antipodean currencies are treated as one by foreign investors and currency speculators and thus the majority of the time move in tandem against the USD.

However, on economic fundamental grounds there are major differences between the two countries.

The Australian economy is highly dependent upon metal and mining prices as its resources sector overpowers all other sectors.

In contrast, the New Zealand economy is almost totally dependent upon the weather, pastoral grass growth and global food commodity prices.

We also see differences from time to time in monetary policy management between the two central banks which leads to interest rate divergence and which in turn is the determining factor in the NZD/AUD cross-rate movements.

NZD movements against the USD relative to the AUD/USD changes are only stronger or weaker when the NZ/Australian interest rate differential suggests they should be.

There has been a view for some weeks now the Australian dollar is living on borrowed time with its latest gains to highs of $1.0550 against the USD.

The metal and mining prices have significantly diverged from the AUD/USD exchange rate. Weaker than expected Chinese economic data over recent weeks has seen global prices for iron ore, steel, coal and aluminium remain stable or fall further.

The sharp pull-back in the AUD from above $1.0500 to $1.0430 on Friday 17 August may well be the commencement of a major AUD downward correction as the AUD has been over-valued vis-a-vis the critical hard commodity prices.

The greater probability from here is that the AUD continues to weaken and slides right back to below $1.0000 over coming weeks.

The AUD/USD rate has failed to sustain gains above $1.0500 on seven separate occasions over the last 18 months (see chart below).

The evidence is building yet again that this latest foray above $1.0500 will also be a short-lived affair. A five or six cent AUD plunge similar to all the others would pull the NZ dollar down at least four cents to the 0.7600 region against the USD.

The two developments that caused the AUD to de-link from the metal and mining commodity prices and move upward were the Reserve Bank of Australia changing their monetary policy stance from an “easing” bias to a neutral “on-hold” outlook and safe haven capital flows out of Europe favouring the higher yields available with Australian Government bonds.

The panic exit out of Europe that we saw in May and June has settled in recent weeks, therefore the hedge funds and investment fund managers who purchased AUD’s back then are much more likely to be taking currency profits and selling the AUD now the European risk has diminished relative to where it was.

Those speculators and investors still sitting on Aussie dollars will be more likely to sell if Australian economic data prints on the weaker side over coming weeks.

The Australian resources companies have been hit very hard with the currency/commodity price breakdown and industry leaders in Australia have a lot of pressure on the RBA and the Gillard Government to do something about the over-valued AUD exchange rate.

The RBA release the minutes of their last meeting on Tuesday 23 August, however that will only confirm their current stance that they are on-hold and awaiting to see the results of earlier cutting of official interest rates. The downward direction of the share prices of the listed resources/mining stocks really already tells you what the RBA need to do. A surprise further easing of monetary policy in Australia could be the catalyst the sends the AUD down further.

The large mining exporters in Australia do not hedge forward their currency risk and therefore have not been protected at all from the recent appreciation of the AUD.

Their sales revenues and profits have taken an immediate hit and new energy/mining investment projects in Australia have been axed as the economics no longer stack up.

Export and jobs are also under threat here in New Zealand from the breakdown in the hard commodity price correlation with the AUD exchange rate.

The Bluff aluminium smelter ultimately owned by Rio Tinto, does not hedge forward the NZD/USD currency risk on their USD export receipts and coupled with falling global aluminium prices they are unprofitable.

The smelter and 700 jobs in Southland are under threat unless they can negotiate cheaper electricity from Meridian Energy or the NZD depreciates very soon. Likewise, state-owned coal exporter Solid Energy New Zealand is reviewing all its operations as profitability falls as they only hedge the currency risk on the quarterly coal price re-sets.

Less panic in Europe, weaker Chinese economic data and stronger US economic data all add up to lower commodity prices and a stronger USD on global forex markets over coming weeks/months.

The RBNZ will eventually need to raise NZ interest rates, however they cannot do that unless and until the NZD currency value pulls back.

The serious situation in Australia is looking like it will be the force behind a weaker NZ dollar in the short to medium term.

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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

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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12 Comments

Agree. NZD is well overdue

Agree. NZD is well overdue for one of its regular 20-30% liquidations. All the speculators will take their profits at once. If you're a foreign speculator/investor holding NZ assets of any description, shares, property or bonds, are you going to wait and see what happens or err on the side of caution and sell looking to buy cheaper later?

Well, once again Roger you

Well, once again Roger you ignore the fundamentals of the elephant in the room.
 
Plus it is not like anyone expects that the US will ever be good for, and repay the $22 trillion (at a minimum) in debt it will have in 4 short years. At best, it will keep rolling all that debt over (at ever shorter maturities) until the USD finally loses its reserve status. Read Article

Roger Kerr says: "The RBA

Roger Kerr says: "The RBA release the minutes of their last meeting on Tuesday 23 August"
 
Which year are you talking about Roger?

Timing is everything and mine

Timing is everything and mine is usually dreadful. For what it is worth, in my own small way I have hedged against a Kiwi fall in the next few months, but I would not be surprised if the Kiwi was 90c against both Oz and US in two years' time.
One thing that may help the Kiwi in the short term is the terrible NHemi droughts. The one in Europe is not widely reported but it is pretty savage.
Cheers

Well John K.....if that

Well John K.....if that little unlikely came to pass, I would advise you (openly) to buy every AUD  or USD you could lay hand to, worst case scenario would be 20% on your money ,even if it dragged on over a year or more.....
I had occassion once , a long while back to buy considerable AUD at 96.......glory be..! no wonder  there are soooooo many parasites in FX, there was this baby , you see, and it had some candy..........

And.... Count Christov and

And.... Count Christov and his vampire family came and sucked the baby's blood dry and ran off with the candies?

Well, er...yes . I would have

Well, er...yes . I would have put it more delicately than perhaps your picture of events, but
(A) never ,ever leave a baby unattended , clutching your purse ,in it's hi tech stroller.
(B) teach babies not to wave candy at strangers ,unless there's an FTT wrapper on the sticky treat.
Stupid Baby.

Parenting is just so

Parenting is just so tough..... I prefer to have pets, because then you can sell the babies.

Or just toss it out with the

Or just toss it out with the bathwater.....Bolly's lost a few that way.

Too much - ROFL - my chest

Too much - ROFL - my chest hurts.