Roger J Kerr thinks the future of both the AUD and NZD will depend on the US Fed's tapering policy actions

 By Roger J Kerr

The depreciation of the Kiwi dollar against the USD over this past month has been more rapid and has occurred in a more volatile fashion than what most would have expected.

Basically, the global investment market’s love affair over recent years with our cousin currency the Aussie dollar has come to an abrupt ending.

As foreshadowed in this column over recent months, the cumulative negatives surrounding the Australian economy and currency have finally been hit home to the forex markets, thus a collapsing over recent weeks of the AUD/USD exchange rate has been the result.

The lock-step decline of the NZD/USD rate with the AUD/USD is a timely reminder to all those with currency risks in New Zealand that our currency (rightly or wrongly) is driven by the Aussie dollar 80% of the time.

While the strong data currently coming though on the New Zealand economy would not support a seven cent collapse of the exchange rate from 0.8500 to 0.7800, the reality remains that the majority of global investors/currency traders do see the two currencies as one and sell the Kiwi alongside their selling of the Aussie.

Therefore, the immediate outlook for the Kiwi dollar is centred on whether the AUD has been oversold on its 10 cent decline from $1.0400 to $0.9400.

The AUD/USD rate has found some buying support at these levels previously over the last three years (see chart below) and a bounce back up to 0.9600 on profit-taking seems more likely than not in the short-term.

The sudden reversal in the AUD’s fortunes is in direct response to weaker than expected Chinese economic data and falling hard (metal and mining) commodity prices globally.

Looking ahead, there is a real question as to whether the monetary authorities in China may now cut their interest rates to re-stimulate demand. Inflation risks in China have reduced and the measures to curtail property market speculation in the major cities are now in place, therefore there would be little risk in cutting their interest rates.

Any cut in Chinese interest rates would be viewed by the markets as positive for commodity prices and thus the AUD.

While the NZD and AUD may have been over-sold in the short-term, the medium to longer term outlook for both currencies appears to be heavily dependent on the extent of USD strength generally as the US monetary stimulus and bond buying is tapered back.

The global FX markets have been marking the USD upwards on continually improving US economic data and thus speculating on how and when the Federal Reserve unwind the quantitative easing program.

What has been somewhat surprising over recent weeks is the return of the EUR/USD rate to $1.3200 over a period when the outlook has become even more certain that US interest rate will eventually move upwards and European interest rates need to be reduced further.

The latest strength in the Euro and UK Pound against the USD are therefore unjustified and should reverse rather quickly.

Therefore, the sharp fall in the NZD/EUR and NZD/GBP cross-rate to 0.5940 and 0.5050 respectively could prove to be very short-lived and thus present ideal forward hedging entry points for local exporters in those currencies. A stronger USD against all currencies over the medium term will see these cross-rates move substantially higher, particularly under the scenario of the NZD being pushed up against the USD on its own account later on when NZ interest rates eventually have to be increased by the RBNZ.

Upcoming economic releases in New Zealand look likely to halt and potentially reverse the current NZD slide.

The quarterly RBNZ monetary policy statement this Thursday 13 June should see a more upbeat assessment of the NZ economy with the drought impact on agricultural production not as bad as first feared and domestic economic activity strong on the back of rising house prices and low mortgage interest rates.

The RBNZ should be more worried about the inflationary impacts of the housing market than what they appear to be at this point.

The now lower currency value below 0.8000 does provide more flexibility for the RBNZ to intimate that interest rates will eventually need to increase due to stronger GDP growth and the wealth affect from rising house prices pushing inflation upwards.

The GDP growth data on 20 June may also surprise on the upside and come out substantially above prior consensus forecasts. The ANZ regional growth survey certainly points to another quarterly GDP increase of above 1.00%.

Such an outcome would be positive for the Kiwi dollar as it would bring forward the timing of the inevitable interest rate increases. 

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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