Roger J Kerr says the reasons traders bought Kiwi dollars are evaporating; a parity party is now unlikely

By Roger J Kerr

The high gloss coating is starting to wear off the NZ dollar, particularly in relation to its value against the neighbouring Australian dollar.

The NZD/AUD cross retreated abruptly from highs of 0.9950 early last week to lows of 0.9705 as speculative traders unwound long NZ dollar positions when it was clear that the push to parity was going to fail.

Stop-loss NZD sell orders have been triggered on the way down, adding to the downward momentum in the NZD/AUD cross-rate.

The Kiwi dollar has weakened back from above 0.7700 against the US dollar to trade at 0.7630 at the time of writing.

The overall value of the Kiwi, the Trade Weighted Index (TWI) has also retraced from highs above 80.0 to 79.20.

The recent NZ dollar selling against the Aussie has come about due to two significant changes in sentiment and outlook in the currency markets:-

• The previous divergence in monetary policy outlook between Australia and New Zealand has reduced as the RBA failed to cut their OCR at the last two review dates and a speech by the RBNZ Chief Economist, John McDermott was interpreted by the financial markets as more chance of the next change in NZ official interest rates being down rather than up.
   
• The previous divergence between Australia’s and New Zealand’s export commodity prices has swung in the opposite direction as copper and iron ore prices recover from their lows, whereas our dairy prices have plummeted in the last three Global Dairy Trade auctions. The superior NZ economic performance to date over Australia could easily turn the other way if our largest industry, the dairy industry, has to endure two years in a row of poor milksolids payout prices to dairy farmers.

It would seem that the smart money is already re-assessing the efficacy of holding NZ dollars in favour of Australian dollars.

The speculative buying of Kiwi dollars out of Aussie dollars that drove the NZD/AUD cross-rate up from 0.9200 to 0.9950 over the last two months appears to be reversing as the rationale for the buying is eroded.

The interest rate differential between Australia and New Zealand, that has been so accurate in predicting NZD/AUD movements over the last 10 years, never ever suggested an exchange rate as high as 0.9950.

The interest differential of +1.50% still points to a NZD/AUD cross-rate in the 0.9200/0.9300 region.

The markets are now focusing on the RBNZ OCR review on Thursday 30 April as another opportunity for Governor Wheeler to jawbone the NZ dollar lower as the TWI at 79.0 is still considerably above RBNZ assumptions of below 75.0.

While the Governor may well repeat his often repeated messages of the NZ dollar currency value being “unsustainably” and “unjustifiably” high against economic fundamentals, the words lose impact and credibility if they are not followed up with action.

The prerequisites for direct intervention in the NZ dollar FX market are still fulfilled and this policy option has to be under current consideration by the RBNZ.

One tactic the RBNZ will be examining to ensure such intervention will be effective is to spark some independent NZ dollar selling with a bearish tone in the OCR review statement and then once Kiwi is weakening in the markets to come in with judiciously timed NZD sell orders of their own.

The RBNZ will be well aware that the only effective way to control the inflationary impact of the Auckland housing boom is to increase mortgage interest rates.

They cannot increase interest rates now with the exchange rate value so high (it would only push the currency even higher).

Therefore their only policy option is to engineer a lower exchange rate value to give themselves some room later on to increase interest rates if they have to.

Over coming months it seems that local NZ developments with economic data, monetary policy and commodity price movements will play a larger role in determining the NZD/USD direction.

The US dollar itself appears likely to stay in the $1.05 to $1.10 trading range against the Euro with no surprises or unexpected events shifting current forex market sentiment.

The European money printing and US interest rate increases in the second half of 2015 are fully priced into the EUR/USD exchange rate already.

A successful RBNZ campaign to push the NZ dollar lower in its own right over coming weeks/months to the low 0.7000’s against the USD should see the cross-rates to the AUD, EUR and GBP move lower as well.

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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