Roger J Kerr says that Yellen's timing and the wholemilk powder prices drops are not positive for the Kiwi dollar

 By Roger J Kerr

The fundamental question for global currency markets is whether the change in monetary policy management wording and timing signalled by the US Federal Reserve last week has provided a turning point in the US dollar value.

Fed Chair, Janet Yellen indicating that interest rate increases were likely to commence about six months after the ending of QE; that is, when the tapering of bond purchases by the Fed is completed by August/September this year.

The resultant timing of interest rate increases now being confirmed by the Federal Reserve for March 2015, which is a lot earlier in 2015 than what the financial markets had been building in previously.

We have been expecting a stronger US dollar against all currencies to emerge once the Fed’s tapering commenced and US economic data continued on an upward path.

However, the US dollar has disappointed over recent months with the winter chill slowing US economic expansion and some market doubts as to how the new Fed Chair, Janet Yellen would play the monetary policy fiddle.

Those uncertainties that have held the US dollar back in the forex markets are now well behind us as the Fed’s position is made clear.

The USD Index has climbed back above 80.0 and the EUR/USD exchange rate is back below $1.3800 after flirting with $1.4000 earlier last week.

The path now appears to be clear for the US dollar to make gains as the Ukraine geo-political uncertainties are not going away and the flow of funds back into Europe from European banks and companies selling offshore assets is finally slowing up.

The main reason for the unexpected Euro strength from $1.3000 to $1.3800 against the USD over recent months has been these repatriated capital flows out of USD and into the Euro.

A turnaround in the performance of the USD against the EUR, GBP and JPY over coming months would see the NZD/USD rate lower towards 0.8000 rather than holding above 0.8500.

A second major development in the foreign exchange markets for the Kiwi dollar last week was another sharp drop in the price of Wholemilk Powder (WMP).

Most local dairy industry gurus were expecting the WMP price to hold up at the record high USD5,000/MT for the first half of 2014 and then drift marginally lower later in the year as new supply from Europe came on stream.

The reality is that additional milk supply has hit the globally traded market a lot sooner and the WMP price has crashed down 10% to USD4,500/MT in the last two Fonterra GDT on-line auctions.

There are no immediate implications for the NZ economy as Fonterra already has the current dairy season’s production all sold six to nine months forward. However, further price reductions over upcoming GDT auctions will have the dairy industry hastily revising down the forecast milksolids payout number for the 2014/2015 season.

There has not been too much of an adverse reaction to the much lower WMP price in the NZ dollar foreign exchange market as yet.

However, many offshore market players do regard our economy as one very large dairy farm, so some of the gloss may be starting to crack for the rock star economy in their eyes.

While the correlation between the NZD/USD exchange rate and WMP prices has been poor over the last three years, the long-term price linkage is undeniable.

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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