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Roger J Kerr says the RBNZ can only retain credibility for its warnings of divergence between dairy prices and the NZD if it acts to get the currency realigned

Currencies
Roger J Kerr says the RBNZ can only retain credibility for its warnings of divergence between dairy prices and the NZD if it acts to get the currency realigned

 By Roger J Kerr

The rapid depreciation of the NZ dollar exchange rate against the USD from highs of 0.8770 in early May to lows of 0.8410 in early June has been temporarily punctuated by an unexpected revitalisation of the cousin currency, the Australian dollar.

The AUD rate against the USD has rebounded back up to 0.9340 following a stronger than expected GDP growth figure for the March quarter released last week.

Australian economic data continues to be a mixed bag with stronger export volumes from the massive mine expansion in recent years pushing the higher GDP numbers, however business and consumer confidence have fallen away since the mid-May budget which increased taxes and cuts to Government expenditure/jobs to rein in the annual budget deficit.

The large capital inflows into Australia to finance the new mining projects that occurred between 2009 and 2012 have reduced dramatically and thus the major driver of the higher Australian dollar has been removed.

The Reserve Bank of Australia has yet to see growth in other industries replacing the mining boom and thus will maintain their interest rates at record lows for at least another 12 months.

The recent improvement in the AUD to 0.9340 does not appear sustainable in the face of an economy that is experiencing a severe belt-tightening for the first time in 25 years.

The downward direction of iron ore and coal prices due to slowing Chinese demand is also at odds with the Australian dollar appreciating.

A lower AUD toward 0.9000 against the USD over coming months stands as a major factor as to why the Kiwi dollar will depreciate back to the 0.8100/0.8200 region.

In the short-term, the immediate focus of the foreign exchange markets will be on the RBNZ’s Monetary Policy Statement on Thursday 12 June.

Three weeks ago RBNZ Governor, Graham Wheeler warned the markets that it would be opportune for the RBNZ to intervene in the NZ dollar FX market to sell the currency if the divergence between economic fundamentals (i.e. milkpowder prices) and the high NZ dollar above 0.8600 continued.

The divergence has continued (even though the Kiwi has come off its highs) with Wholemilk Powder prices plummeting another 10% lower since the Governor’s warning statement.

For credibility reasons the RBNZ do need to follow through on their warning about the implications for the NZ economy if the price divergence continued.

No-one is expecting direct intervention NZD selling across the currency markets, however what is expected is that the RBNZ will significantly revise downwards their inflation, GDP growth and thus interest rate forecasts from their March economic outlook.

Such forecast revisions should generate a negative response in the FX markets and NZD selling.

The interest rate markets are already pricing-in a lower interest rate trajectory through 2014 and 2015.

The FX markets have to date ignored the lower interest rate track as the recent Australian dollar positive influence has outweighed the domestic moneymarket variable.

The RBNZ statement on Thursday will be a timely reminder to all the markets that the so-called “rock-star” economy is sailing into rougher waters due to our dominant export commodity tumbling in price.

It has taken some time for local economists to recognise and understand the implications of the material decrease in both milk powder and forestry log prices over recent months.

While still going ahead with the third 0.25% OCR increase to 3.25% this Thursday, the RBNZ have a golden opportunity to jawbone the NZ dollar lower and do not have to risk taxpayer’s money by intervening directly in the FX markets.

The short-term bounce upwards from 0.8410 to 0.8500 in the NZD/USD exchange rate may well be regarded by some offshore “carry-traders” and local fund managers alike as an opportunity to off-load long NZD positions at rates not too far from the top.

The foreign buying interest in NZ Government bonds which was so strong earlier in the year has also waned over recent weeks along with lower issuance levels for Kauri bonds. The sentiment towards and thus demand for the Kiwi dollar has reduced.

The US dollar itself is finally making gains against major currencies as the Europeans deliver on a monetary stimulus package (negative for the Euro) and US economic data continues on a stronger path.

While the EUR/USD rate appears to have paused at $1.3600, the forward look has to be a fall to $1.3000 over coming weeks/months as US economic performance is at the complete other end of the scale to a faltering European economy that requires further monetary resuscitation.

The NZD/USD rate remained generally correlated to the EUR/USD rate, thus establishing the third principal reason for a lower Kiwi dollar behind a RBNZ nudge and a weaker AUD. 

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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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