Roger J Kerr says the return of the NZD to 80 USc has been postponed in timing by RBNZ policy choices but not fundamentally changed

 By Roger J Kerr

The "NZ Dollars for sale" sign has been put up again by the Reserve Bank of New Zealand as they tighten monetary policy at a time when the rest of the world continues to run very accommodative / loose monetary regimes.

Increasing NZ interest rates makes our currency relatively more attractive to global investors and FX speculators, especially when the central bank surprises the market with a more hawkish than expected Monetary Policy Statement.

NZ dollar strength against all currencies is inevitable in such circumstances.

The TWI Index has returned to its post-float highs of 81.00.

The RBNZ had the opportunity in the 12 June statement to create doubt in the minds of international currency market players that the NZ dollar is not a one-way bet. That action would have been consistent with RBNZ Governor Wheeler’s threat about NZD intervention four weeks earlier.

However, for domestic economic/inflation reasons they chose to reinforce the one-way FX bet and underwrite the Kiwi dollar risk (for the meantime!) for the offshore investors.

The revision down in the RBNZ inflation and GDP growth forecasts from the March economic prognosis would normally automatically lead to the future interest rate forecasts also being adjusted downwards. The surprise element in the recent RBNZ stance is that they left the forward guidance on future 90-day interest rates unchanged, despite the lower inflation/growth forecast.

The RBNZ are clearly now more worried about high immigration inflows and low fixed rate mortgage interest rates boosting the housing market and fuelling inflation than they are about profits, jobs and investment in the export sector.

The New Zealand financial markets and economy have now returned to one of those periods when there is a direct clash between the asset prices in the cities and incomes/jobs in the rural provinces.

At the end of the day the latter drives the economy.

The bluntness of the interest rate monetary policy tool is again in the spotlight in terms of where the adjustment pain is worn.

Luckily, reasonably high international dairy and meat prices are partially compensating the high currency for the meantime.

Further decreases in wholemilk powder prices while the NZD exchange rate is pressured higher by rising interest rates would extenuate the divergence between economic fundamentals and the exchange rate that Governor Wheeler warned about in May, however strangely forgot about in early June.

The RBNZ had postponed the “normalisation” of short-term interest rates in the NZ economy well into 2014 by such unconventional measures as the LVR speed limits on bank mortgage lending in the hope that US interest rates would be increasing at the same time as NZ interest rates and the upward pressure on the NZ dollar would not occur.

As it turns out New Zealand is still 12 months ahead of the US in increasing interest rates after the post GFC period of record low interest rates.

The RBNZ have been frustrated that the US dollar itself is not strengthening on the global currency stage at this time to offset NZD strength from rising interest rates.

US Federal Reserve Chair, Janet Yellen reinforced her overly cautious approach to the unwind of monetary stimulus last week, seemingly unconvinced that the growth in US employment is robust and sustainable. The US dollar weakened back as the current Fed stance was more dovish than expected.

However, US stronger economic numbers continue and forward looking indicators of inflation point to increases that the Fed may be underestimating at this point in time. The markets are likely to price US long-term interest rates and the US dollar higher as the higher inflation evidence transpires over coming months.

The EUR/USD exchange rate has paused at the $1.3600 level as the markets absorb the Fed’s latest stance, however a weaker Euro and thus stronger US dollar does seem inevitable going forward given the growing divergence in US/European growth and inflation trends.

As expected, the Australian dollar has encountered a fair amount of resistance at 0.9400 against the USD and has been unable to push higher. The RBA is now recognising the downside risks to Australian economic growth from tumbling iron ore prices (down 34% this year) and a rising AUD currency value.

Once the strengthening path of the US dollar re-emerges in global FX markets the AUD’s vulnerability is likely to be exposed as their economic data and commodity prices are not positive enough to support the currency.

Despite higher interest rates in New Zealand, the Kiwi dollar still closely follows the Euro and AUD in the forex markets. Weaker Euro and AUD values over coming weeks should ensure a NZD/USD retreat from 0.8700.

In any case, the FX markets do seem reluctant to push the NZ dollar above its previous high of 0.8770 and profit-taking on the gains from the RBNZ surprise 11 days ago will support the NZD selling.

The forecast return to 0.8000 for the NZD/USD exchange rate has been postponed in timing, however not fundamentally changed. 

-----------------------------------------------------------

To subscribe to our daily Currency Rate Sheet email, enter your email address here.

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