By Roger J Kerr
Last week’s “NZ dollar foreign exchange rate” all-day forum held in Wellington to debate how and why the NZ dollar is considered over-valued and what may be done about it unsurprisingly concluded that the current free-floating exchange rate regime is the most appropriate for the NZ economy, warts and all.
The debate and free exchange of ideas/theories about the exchange rate between academics, civil servants, bankers and business folk was the typical talk-fest with most ignoring or oblivious to the “elephant in the room.” That is, changes to the value of the US dollar on the international stage accounts for 60% of the NZD/USD exchange rate movements and therefore nothing we can do in New Zealand to change economic policy (fiscal or monetary) will influence the level or direction of the NZ dollar currency value.
Only 20% of the movements are due to New Zealand specific economic events, trends and policy announcements and the remaining 20% is unexplained.
The “unexplained” portion would have to be hedge funds and currency speculators taking long or short NZD positions depending on which way global investment sentiment is going on any particular given day.
Therefore 80% of the forces that push the NZ dollar up and down on the global foreign exchange markets were pretty much left out of the debate.
Fortunately, it is well understood in the export business community (even if only partially understood by the mandarins in Wellington) that what the USD itself is doing in world currency markets is the major risk on NZD/USD movements.
Therefore, USD exporters who cannot change their USD product selling prices easily need to hedge forward a considerable way when the market provides dips to competitive exchange rate levels.
The reality of the NZ economy is that it must have an automatic shock-absorber mechanism to protect jobs and incomes when global food commodity prices fall due to demand or supply reasons (and that is precisely what happened in the GFC in March 2009).
The fall in prices of what we sell being matched by NZD currency depreciation provides the offset and thus stable NZD export returns.
The cost of that automatic shock-absorber for exporters are the periods of sustained NZD appreciation due to a weak USD or some other global situations that render the NZ dollar attractive and safe for global investors.
Rather sadly, the fundamental requirement for exporters to hedge against the currency market forces outside our control (USD weakness) was missing from the Wellington talk-fest.
What was agreed at the forum was that to reduce the periods of NZD over-valuation, we need to increase Government and private savings levels.
A larger savings pool within New Zealand would reduce the dependence on foreigner’s savings to fund the shortfall between our total saving and investment requirements. Unfortunately, the policy prescriptions to increase savings rates are easier said than done!
Exporters who have been operating a medium term and disciplined currency hedging policy and buying forward NZD’s on the regular dips to 0.8200 against the USD have again been rewarded of late as the Kiwi dollar yet again bounces off the bottom end of its trading range.
The stronger than expected GDP growth result for the December quarter provided the initial impetus for the Kiwi dollar to move back upwards.
The second impetus came from safe-haven investment inflows out of Europe as the Cypriot banking crisis scared investors about precedents being established for the creaky Spanish, Italian and Portuguese banks.
Evidence of the safe-haven flows into the NZ dollar was seen with a sharp jump higher in the NZD/EUR cross rate from 0.6350 to 0.6550. The Euro has weakened to $1.2800 against the USD, whereas the Kiwi has made gains for the reasons mentioned above.
The NZ dollar has also out-performed the AUD cousin currency over the last week with the NZD/AUD cross-rate returning to above 0.8000 from lows of 0.7900. Australian economic data continues to be a mixed bag; however the Aussie moneymarkets have reduced the probability of further RBA cuts in their OCR. Metal and mining commodity prices, however are no longer rising and latest Chinese economic figures do not support any large increase in demand for Australia’s resources.
US economic data continues to improve with the markets again focusing on the upcoming monthly employment statistics for March which should again confirm the strong pick up in the economy at the household level of retail spending, residential real estate and thus jobs in the massive service sector.
The global foreign exchange markets are now happily interpreting stronger than expected US economic data as positive for the US dollar currency as the markets anticipate an earlier withdrawal of monetary stimulus by the US Federal Reserve.
A US jobs number above a 200,000 increase for the month of March should see further USD gains against the Euro to $1.2600.
Upcoming international economic developments of the Cyprus-related safe haven flows reducing as the market moves on and stronger US economic numbers therefore favour the Kiwi’s current foray above 0.8300 being short-lived.
In the medium term, a stronger USD against all currencies points to a Kiwi dollar nearer 0.8000 than 0.8500.
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Roger J Kerr is a partner at PwC. 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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