Roger J Kerr looks at how Canada's currency has fared recently, and finds senarios that could see the NZD 'suffer' similarly. Your view?

 By Roger J Kerr

Drawing parallels of the NZ dollar with other currencies can be instructive for analysing likely future movements, however it can also be dangerous as what one currency does in a certain economic/market climate does not automatically hold for another currency.

However, for those who think the NZ dollar is now a stellar, stand-out and top performing currency due to our “rock-star” economy, a study of the recent (mis)fortunes of the Canadian dollar (the “Loonie”) may temper those bullish expectations.

The Loonie belongs to the same currency club as the Australian and New Zealand dollars, commodity currencies that follow global growth trends and thus they attract speculative currency traders seeking to position for the ups and downs in global investor sentiment.

The AUD and the CAD both strengthened against the USD after the GFC as commodity/energy prices increased and the USD weakened on the Fed’s QE monetary stimulus policy.

The AUD started to lose its gloss mid way through last year and has been on a weaker trend every since.

The Loonie remained strong at $1.0000 to the USD up until late 2013 on the expectation that Canadian interest rates would be increased.

The CAD has been sold down heavily in the FX markets since December, tumbling to $1.1100 to the USD, a 4 ½ year low.

Expectations of interest rate increases have been dashed by weak Canadian economic numbers, gas sales across the border to the US are down with gas prices also down due to the shale gas production revolution in the US economy and commodity prices are off generally as disinvestment form Emerging Market economies have all markets nervous right now.

The Loonie has rapidly fallen out of favour in world currency markets.

It may not look like the Kiwi dollar will suffer a similar fate in the short-term, however a postponement of our interest rate increases and falling wholemilk powder prices would turn sentiment against the NZ dollar in the same fashion as the tables turned on the Loonie.

The NZD/USD rate has broken out the bottom-side of the 0.8250 to 0.8400 trading range that held through December and most of January.

The recent depreciation to below 0.8100 caused by a combination of factors:-

- A number of FX market players clearly went into last Thursday’s OCR review by the RBNZ long the NZD in expectation of gains when the OCR was increased. That did not happen (it was never going to happen) therefore the NZD traders were forced to sell the NZD’s back to the market.

- The USD strengthened against all the major currencies when the Federal Reserve reduced their bond buying by another $10 billion per month as they signalled they would do in the progressive tapering plan. The USD also made gains as funds moved out of Emerging Market currencies.

- RBNZ Governor Graeme Wheeler stated in a post OCR review speech in Christchurch that he still considered the NZ dollar significantly over-valued and it was a major headwind for the economy. The latest jawboning down of the currency proving more effective, as the RBA have been providing the master-class of how to talk your currency value lower of late.

- As expected, the unwinding of long NZD/short AUD positions that drove the NZD/AUD cross rate from 0.9000 to 0.9400, has finally eventuated with the plunging Kiwi on its own after the OCR “no change” being the catalyst. The NZD/AUD cross-rate has pulled back sharply from highs of 0.9460 to 0.9240.

A push below 0.8000 now appears more likely for the Kiwi than a return to 0.8200/0.8300.

The USD is set to strengthen further in global FX markets as the US economy out-performs in the GDP growth stakes.

The second six months of 2013 saw the strongest half-yearly GDP expansion of the US economy in 10 years.

The EUR/USD exchange rate has come back to below $1.3500 from $1.3700 as the USD makes gains on the Fed tapering.

Very low inflation results in Europe are likely to lead to further monetary loosening measures form the ECB.

The Euro is destined to weaken substantially in 2014 as the monetary conditions in Europe move to be exactly the opposite to the unwinding of stimulus in the US.

Local exporters selling in Yen and Euro will be taking advantage of the current lower JPY/NZD and EUR/NZD cross-rates as the future risk is that the cross-rates increase significantly as the Yen and Euro fall further against the USD than the Kiwi dollar does, due to rising interest rates in New Zealand over the remainder of 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