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Roger J Kerr says the 'stark reality' is the strong NZ dollar is causing weaker economic fundamentals which are about to hit the economy

Currencies
Roger J Kerr says the 'stark reality' is the strong NZ dollar is causing weaker economic fundamentals which are about to hit the economy

 By Roger J Kerr

Over recent weeks there has been much commentary and analysis of what factors have driven the NZ dollar currency value to record post-1985 float highs.

Reasons cited range from the” rock-star” economy attracting capital inflows, to rising NZ interest rates when the rest of the world remains at 0%, to global investors entering “carry-trades” in the chase for yield return and aggressively buying the Kiwi dollar, to benign conditions and extreme low volatility in international investment/financial markets, to positive reports on NZ from credit rating agencies and a weak US dollar.

The US dollar itself has in fact moved sideways over the last two years and has not been a factor in pushing the Kiwi dollar up.

The Fitch credit rating report was arguably six months out of date as they referred to the record high dairy prices, which have plummeted more than 30% over the last four months.

The high flying Kiwi dollar is off course great news for consumers enjoying discounted prices on imported goods.

However, the latest push upwards in the NZD/USD rate to 0.8800 has been disastrous for the economy in respect to exporter profitability, productive output, business investment in our most important industry sectors and thus jobs.

The negative implications from the over-valued exchange rate for the overall economy over the next six to 12 months are serious and considerable.

Surprisingly, there appears to date to be scant recognition and understanding of what this latest currency appreciation means in real terms.

Over recent years our export companies have been better hedged forward against adverse exchange rate movements than ever before.

However, the prolonged period above 0.8000 over the last nine months has meant that the legacy hedging contracts are running out.

For many exporters converting USD sales receipts above 0.8500 is doing business at a loss.

They will not tolerate that situation for long and many are already cutting back production and thus their workforce.

While the economy enjoyed record high agricultural export commodity prices (up until four months ago) the negative impact of the high Kiwi dollar was counteracted and disguised to some extent.

A lot has changed over recent months.

International dairy prices are dramatically down 30% and are likely to go lower.

The stark reality of the NZ dollar strengthening and diverging away from weaker economic fundamentals (i.e. lower wholemilk powder prices) is about to hit the economy.

Current forecasts of 3.5% plus GDP growth will need to be hastily revised significantly lower as a Fonterra milksolids payout closer to $6.00 for the next 2014/2015 season compared to $8.40 last season wipes $3 billion off dairy farmer incomes.

The recent collapse of export log prices has caused 'carnage' in the forestry industry as small to medium operators stop cutting trees completely.

Adding to the rapidly deteriorating export industry situation is lack lustre consumer and industry demand from our largest export market, Australia. A NZD/AUD cross-rate above 0.9300 compounds the problem for exporters into Australia.

Eventually, the negative impact on our economic performance will be more widely recognised and understood, resulting in the NZ dollar depreciating.

Sharply lower dairy prices will also eventually pull the NZD lower. The Fonterra/GDT auction this Tuesday night will again confirm the soft underbelly in the demand/supply equation of the global wholemilk powder market.

Wednesday’s June quarters’ inflation data could surprise on the low side with imported consumer goods still going down in price, as are insurance and telecommunication prices. The consensus + 0.4% forecast for the quarter (1.80% annual rate) may well be higher than the actual outcome, forcing some re-thinking at the RBNZ.

To counteract the Reserve Bank of New Zealand pushing the NZ dollar up with increasing interest rates at this time, the only short term hope for our export industries has to be a stronger US dollar on global markets when Federal Reserve Chair, Janet Yellen is ultimately forced to change her tune on US monetary stimulus policy.

Unfortunately, the inevitable change to the Fed’s rhetoric may still be a few months away.

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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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5 Comments

Thank for such a clearly realistic sum-up of our current situation Roger.

 

I often find your postings hard to follow. This one is crystal-clear. Brilliant.

 

I have owned both a manufacturing export business and an import / distribution business. Life was like riding a see-saw. As one business suffered exchange rate madness - the other boomed.

 

I am pleased to now be 95% retired. Todays business climate would be - to say the least - difficult. My decision making would be rudderless.

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Supporting Roger's dairy analysis Bloomberg had an interesting longer term piece (http://www.bloomberg.com/news/2014-07-11/milk-output-expansion-poised-t…) projecting a world surplus milk supply over the next few years. There was a nod to how El Nino may reduce the surplus but otherwise the conclusion is that it looks black for NZ$ receipts.

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As a fully paid-up member (in fact, the sole one, but let that pass) of PETT - People for the Ethical Treatment of Trees - may I register a strong protest about the following fact gleaned from the article:

 

"as small to medium operators stop cutting trees completely".

 

Like shark-finning, failure to cut a tree completely leads to needless arboreal suffering.  No, wait, sharks aren't arboreal, they're - um - Aquatic.  I think,  Or something.  But I'm sure you get my drift.

 

Trees should be cut completely, or not at all.  Leaving them Incompletely Cut is an outrage to the Expanded Circle of Empathy.  

 

cc Tree Surgeons Registrar, Medical Council

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Roger,

Well done on championing what seems obvious to many of us, even if you seem a little late to the party in making this argument. You haven't really spelt out the solutions, other than maybe a delayed 25bps interest rate rise, (which would likely not make a big difference one way or the other, apart from its possible symbolism) and have not quite yet made the jump to the Labour policy of amending the Reserve Bank Act to consider the Current Account as well as inflation. In my view you get there in the end if you follow your own argument. Keeping the inflation only target means the exchange rate will always be overvalued while we have assets to sell or mortgage.

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