Roger J Kerr says the divergence of our TWI from the USD is not sustainable and he is expecting a correction

 By Roger J Kerr

My view that the latest Kiwi dollar spike higher above 0.8300 would be short-lived has been stymied somewhat by surging Wholemilk Powder prices and a herculean Japanese gamble that endless printing of Yen will cure their economic malaise they have been in for the last 15 years.

However, those two recent positives for the Kiwi dollar have probably run their course already and will not repeat.

Looking ahead, the usual drivers of NZD/USD direction, AUD and general commodity prices, are more likely to re-exert themselves and both are looking soggy again.

Oil, gold and base metal prices are trending lower as Chinese stock rebuilding demand has come to an end.

Next week there is a stack of US and Chinese economic data for the global FX markets to contend with, however this week the focus will be on Australia with their March employment figures likely to be a fall following the inflated 71,500 increase in new jobs in February.

Instructively, the AUD failed to appreciate against the USD on the weaker US jobs figures last Friday that caused some recovery of other major currencies (EUR, GBP and CAD) against the USD.

Falling hard commodity prices with the CRB Index down to 288 hurt the AUD and it could well move lower form $1.0370 this week if they have a weak employment number.

Historically, the AUD/USD rate has had quite a strong correlation to the JPY/USD rate as Japan is a key export market for Australia mining production.

Both the AUD and JPY were regarded as safe-haven currencies (and thus strengthened) through the 2009/2012 period of GFC turmoil in Europe and the US. The Yen has now plunged in value since December, so the outlook for the AUD has to be negative.

Also negative for the AUD value against the USD is the recent divergence from its long-term correlation to the gold price.

Gold has recoiled from its highs of almost $1,900 per ounce two years ago and has lost its appeal as the world’s financial system has not imploded as many feared.

Investment in gold does not provide any yield return in a world seeking some return (aka demand for Mighty River Power shares and its secure 6% plus dividends). It is difficult to see gold shooting upwards anytime soon, therefore AUD depreciation looks more likely and that dragging the Kiwi down with it (chart below).

Those with NZD/USD currency risks must also not loose sight of the fact that the USD itself was a currency under downward pressure from 2005 until 20011, the USD currency Index falling from 90 to 72.

However, the USD is now staging a recovery as the Yen, Pound and Euro all weaken for their own reasons.  The USD Index has recovered up to 82 and a movement above 85 over coming weeks will cause a break-out of its long-term downtrend channel (see chart).

Foreign exchange markets are already starting to price in to the USD value a gradual phasing out of US monetary stimulus and will continue to do that this year.

Lower gold prices and and higher USD Index point to a lower NZD/USD exchange rate from current levels above 0.8400. The divergence of the New Zealand Trade Weighted Index (TWI) from the USD Index is not sustainable (see chart below).

Our economy is relatively impressive, but not that impressive.

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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