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Roger J Kerr says history says the NZD/AUD forays into the 0.9000’s never last long and the two economies eventually re-align

Currencies
Roger J Kerr says history says the NZD/AUD forays into the 0.9000’s never last long and the two economies eventually re-align

 By Roger J Kerr

For many years the dominant influence over NZD/USD exchange rate movements has been AUD/USD rate changes.

The Kiwi dollar has been closely linked to the fortunes of the Australian dollar for many valid reasons, the most powerful being that global hedge funds when trading the AUD for Chinese economic or commodity price reasons, just add a few Kiwi dollars onto their speculative AUD positions.

These short-term flows across the FX markets lead to the Kiwi tracking the AUD over any 24-hour period in the markets.

However, the strong currency correlation, like most correlations, does not always hold 100% of the time.

Analysis suggests that the Kiwi mirrors the AUD 80% of the time.

Over recent weeks we have witnessed one of the periods when the two currencies have de-linked with the Kiwi not been sold with bouts of aggressive selling of the Aussie dollar.

Since the Kiwi dollar floated in 1985 there have been several occasions when the NZD has seriously outperformed the AUD against the USD, resulting in the NZD/AUD cross-rate zooming upwards into the 0.9000’s.

The historic patterns of when this occurs suggests that the push above 0.9000 in the NZD/AUD cross-rate always happens when monetary policy in the two economies diverges and moves out of synch.

Such is the current situation today with weak economic data in Australia keeping the RBA on a loosening bias; whereas the very strong economic performance in New Zealand is pressuring the RBNZ to tighten monetary policy with OCR increases sooner rather than later.

History also tells us that the NZD/AUD forays into the 0.9000’s never last for too long and the two economies always eventually re-align with each other.

Last week a 31,000 decrease in Australian jobs contrasted starkly with the robust GDP growth and high business confidence in the NZ economy. The AUD was sold down in the foreign exchange markets against the USD from 0.9000 to 0.8800, whilst the NZD/UDSD depreciation in the face of a stronger USD globally was a more muted fall to 0.8250.

The inevitable impact NZD/AUD cross-rate was a continuation of the sharp uptrend to above 0.9400.

As FX markets always price the future into today’s exchange rate, the question has to be asked as to whether all the very favourable NZ economic news is now fully priced into the NZD/USD exchange rate and further independent NZD gains are unlikely as the good news cannot just keep on repeating.

Given the Kiwi’s over-extension against the beleaguered AUD, a number of developments over coming weeks and months could prove to be more negative for the Kiwi on its own:-

  • Large trading positions, long NZD/short AUD, just have to be unwound at some stage following the six cent spiral in the NZD/AUD cross-rate from 0.8800 to 0.9400.
  • Interest rate and FX markets seem to be expecting an immediate OCR increase by the RBNZ on 31 January – they stand to be disappointed with inflation still too low, the exchange rate still too high and insufficient time for the RBNZ to evaluate the impact of LVR’s on the residential property market.
  • Wholemilk powder prices commence a correction downwards as European and American powder supply comes onto the market to meet the high Chinese demand due to their domestic supply being severely reduced by herd reductions as a result of foot and mouth disease.

There remains considerable confidence that the NZ economy will expand by 3.5% to 4.0% this year and this expectation has prompted international investors to single out the NZ dollar for special/favourable treatment.

However, food and manufacturing exporters into Australia will be hit hard by the high NZD/AUD exchange rate and it will only take lower milk powder prices or a slowing housing market to dent the buoyant mood in New Zealand right now.

In world currency markets, the USD is finally making gains against the Euro following another reiteration from the ECB that they will ease their monetary conditions further.

A lower NZD against the USD and higher NZD/EUR and NZD/GBP cross-rates still appears to be the more likely scenario for 2014. 

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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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3 Comments

He is probably right  they will diverge again , given the stark differences between the two economies in size, scale, scope and in the fundamentals  .

By fundamentals I mean , we are a bunch of farmers who do some mining and a bit of manufacturing  , and Aussies are a bunch of miners , who do some farming , a bit of fishing and a lot of manufacturing ( for now ) .

The real risk is that the current Kiwi $ strength could  outlast the Kiwi manufacturers ability to keep going 

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The NZ and Aus economies haven't synchronised since before the GFC. Aussie benefitted from their Chinese driven terms of trade. Let's not forget the NZD/AUD was decoupled in the other direction when the NZD was buying only .75 AUD not too long ago.

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You need a new crystal ball

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