By Roger J Kerr
The 23 cent depreciation of the NZ dollar from US88 cents to US65c over the last 12 months was due to a variety of factors that arguably will not be repeated over the next 12 months.
Picking the exact bottom of the downward movement is fraught with danger; however, at the current spot rate of US65c we must be approaching a level where fresh new speculative sellers of the currency should start to dwindle in number. The FX market is very short-sold NZ dollars in their positioning at this point in time and unless new lows are reached there will inevitably be a bounce back upwards on profit-taking (i.e. buying back of the Kiwi dollars).
The New Zealand currency has been battered of late with a series of poor economic outcomes driving the negative sentiment and selling – tumbling dairy prices, falling global share indices, low inflation, lower GDP growth, cuts to local interest rates, falling business/consumer confidence levels, a weaker AUD and a generally stronger USD.
Looking ahead, the question is whether the forex market has exhausted itself with re-rating the NZ economy from “Rock-Star” status to something more ordinary. The good news for our economy is that the automatic stabilisation/shock absorber mechanisms that our free floating exchange rate regime delivers when our key export commodity price plunges, are working very well. The weaker NZD value partly compensating the plummet in wholemilk powder prices to reduce the negative impact on exporter/farmer returns. Of course, dairy exporters already have currency hedging contracts in place at higher NZD/USD levels for the next six to 12 months, so the full benefit of the lower 0.6500 exchange rate will be muted in the short to medium term.
Over its history as a free-float exchange rate since 1985, the Kiwi dollar has displayed a tendency to over-shoot on both the top-side and bottom-side. It was downward spiralling export commodity prices and rapid cuts to interest rates that caused an over-shooting to US50c at the time of the GFC in 2009. Within 12 months of bottoming at US50c in early 2009 the NZD/USD rate had bounced up 22 cents to US72c. There are no expectations that this will re-occur on this occasion, however there are five reasonable reasons why we may be approaching “over-shoot” territory to the downside once again:-
- Dairy prices will recover – The inventory overhang in China still appears to be a factor holding prices down over the next three to six months, however, beyond that timeframe the global supply/demand equation starts to even up. The smart food manufacturers who are the end users will start to hedge/buy well before that time and the incentive for US and European milk powder producers to export is just not there anymore with WMP prices below USD2,000/MT.
- Interest rate cuts already fully-priced in – Economic data points to two of three more 0.25% OCR cuts by the RBNZ, the FX markets have already built this in to current pricing and thus further NZD selling on the actual reductions is unlikely.
- USD gains on rising interest rates fully priced in – The USD Currency Index has already appreciated 38% from 71 in 2008 to 98 today on the expectation that US monetary policy will eventually be returned to normal and US interest rates will be higher. Federal Reserve boss Janet Yellen is taking a slow and measured adjustment process to higher US interest rates so as not to scare the FX and equity market horses. Further significant US dollar appreciation seems unlikely.
- Euro should stabilise around $1.05/$1.10 to the USD – Greece did not default and was not kicked out of the Euro. Euro-land economic growth is slowly improving, thus no real need for any further sell-off in the Euro currency value.
- Markets have over-reacted to Chinese factors? – The more negative economic and sharemarket news coming out of China has depressed hard commodity prices and the AUD. Sign are emerging of some stabilisation in the rate of slowdown in Chinese economic data as their lower interest rates help activity levels, thus the markets may have over-reacted.
Our Prime Minister (being a former currency trader) correctly picked the NZD appreciation to US88c and subsequent demise to US65c. He is now defending the economy as it seems the majority of local commentators have become overly-pessimistic. It is likely that we will not know where the NZD/USD bottomed-out until it is four to five cents higher than the actual bottom. For this reason exporters have to be averaging into longer-dated hedging on the way down, as it is just too hard to do it on the way back up. Movements over the next three months will determine just where the bottom is and thus set the pattern for the next 12 months.
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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
12 Comments
"speculators" and "profit taking" so really these ppls actions to make themselves money for no real work/goods made is costing me money or making my not buy, so the net gain for NZ is what? If its a similar impact on businesses then it looks rather parasitic and damaging.
I hope it bounces back.....but I wonder with milk prices gone bye bye if that bottom is near yet.
Steven... Speculators play a fundamental role... They are a part of the mkts. that allows the hedging/transfer of risk and they also help provide liquidity.
In that sense.... they are not parasites... they have a legitimate role to play.....
And yes... I can see how it has evolved into such a size that the tail wags the dog...which aint so good..
Maybe once in the past, however now I believe they do more harm than good. I can agree with the hedging role in theory and its valid. In practice this isnt how it seems to go these days. I am now coming to the conclusion they control the markets and abuse them, yes its the tail wagging the dog.
I think a sustained, sub-$4 payout alongside a retreating Canterbury rebuild effort will just about do it - I'm not as confident as some that there's a bottom coming for commodities anytime soon, a dead cat bounce, maybe. I see the Chinese slowdown (or meltdown) as being more serious and prolonged than our PM seems to believe. It occurs to me that the momentum of the NZ economy as a whole seems to have well and truly peaked and I'm a firm believer in the law of averages. The thing that really worries me is a potential resurgence in inflation just as things are really starting to go south - I know that doesn't make much sense from a traditional standpoint, but nor does flat CPI inflation coupled with a 25% rate for Auckland housing. Big reversals coming on a number of fronts, but the NZD is not one of them (oh, and I have it on good authority that the sky is falling, take cover!).
Well how about you say why not?
for me a) CPI is already close to 0, too close. b) dairy is looking bad for several years out? due to excess capacity and poor demand. That suggests to me rural NZ is in for a quiet few years as farmers lack of ability to spend feeds through into their economies and services. c) What else is there that will stop a recession? Imports will look more expensive as the dropping NZD will push prices up (or try to) yet NZers have no more $s in their wallet suggesting to me retail will go slower still. d) Petrol will go up I expect as its "essential" taking yet more $s out of ppls wallets. So 2 big bits of the economy look ikky.
So what substantial bit doesnt? financial wizardry?
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