By Roger J Kerr
The RBNZ have consistently delivered a message over the last 12 to 18 months that in their view the NZ dollar value is unsustainably high.
Four weeks ago in a speech in Hamilton, Governor Wheeler repeated the message as he witnessed tumbling dairy prices and concluded that the currency/commodity price correlation would drive the NZ dollar lower.
If the price divergence continued he warned that the RBNZ may have all the prerequisite criteria in place to directly intervene in the FX markets by selling the NZ dollar.
Everyone knew that direct FX market intervention was unlikely, however that the upcoming 12 June Monetary Policy Statement would be the opportunity for the RBNZ to send the dollar downwards with a lower interest rate guidance trajectory.
To the contrary, the RBNZ monetary policy setting decisions last week pushed the NZD/USD rate up from 0.8500 to 0.8670.
The RBNZ would have known in advance that an interest rate forecast above the market forward pricing at the time would send the NZ dollar higher.
The same market reaction occurred in March and April; therefore RBNZ rhetoric about the high dollar rings very hollow when they are on a path of increasing interest rates well ahead of the rest of the world.
As I have stated on numerous occasions in the past, exchange rate movements play a dominant role in the New Zealand economy. High export activity and high import penetration levels relative to the size of the economy results in significant sensitivity of exchange rate movements to overall economic performance.
A high dollar over recent years has kept tradable inflation negative, disguising consistently high non-tradable inflation. Export sector investment and jobs are directly related to company/industry profitability and prolonged periods of a high exchange rate reduce all three.
What can change and/or delay the impact of exchange rate movements on the economy is currency hedging.
The previous RBNZ Governor, Alan Bollard took a keen interest in to what extent exporters and importers were hedged forward as he knew the hedging would impact on both inflation and exporter profitability (i.e. GDP growth). Alan would casually wander into our Auckland office for a meeting to ask about hedging levels and horizons in the companies we advise.
My observation today is that major importers are currently heavily hedged out beyond 12 months (much higher than is the norm for importers).
Therefore, a falling NZ dollar value would have a muted and much delayed impact on inflation. According to a BNZ survey of exporter hedging two months ago the average hedging term was just four months. I doubt that exporters would have been adding to their hedging at 0.8700 over the intervening period, therefore surveyed exporter hedging has reduced to just two months forward.
The export economy related sensitivity to the currency is now at extreme levels. There was no comment at all in the RBNZ’s statement last week on currency hedging. Their mandate to control inflation may be narrow, but not that narrow!
Irrespective of RBNZ action and words pushing the NZD temporarily up, there is respite on the horizon for exporters as the following factors ultimately point to a lower NZD/USD rate:-
· The USD itself is finally strengthening against major currencies with the USD Index moving up from 79.00 to 80.60 over recent weeks.
· The AUD has encountered major resistance against the USD at 0.9400 previously and the RBA will not be comfortable with an appreciating AUD when iron ore and coal prices have headed the other way.
· Milk powder prices are likely to fall further (the RBNZ are forecasting this) and in the end the historical correlations strongly suggest the Kiwi dollar will follow.
Our GDP growth numbers for the March quarter will be an impressive +1.1% when released this Thursday, supporting the favourable international view of the NZ economy and currency.
Offsetting that positive for the Kiwi this week should be a stronger US dollar on global FX markets as the US Federal Reserve start to discuss stronger growth and rising inflation in their economy.
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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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