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Roger J Kerr says foreign exchange markets are recognising that previous negatives for the NZ dollar and economy have reversed

Currencies
Roger J Kerr says foreign exchange markets are recognising that previous negatives for the NZ dollar and economy have reversed

By Roger J Kerr

The New Zealand dollar has quietly posted some impressive gains over recent days following Fonterra’s announcement last week that the milksolids forecast payout for the 2015/2016 dairying season has been substantially increased.

It seems that the foreign exchange markets are starting to recognise that the previously dominating negative for the NZ dollar and economy, plummeting dairy commodity prices, have reversed in direction and the future outlook for international wholemilk powder (“WMP”) prices is now much more positive.

The last GlobalDairyTrade (“GDT”) auction saw WMP prices increase 20% to US$2,500/MT and WMP futures prices are now currently quoted at US$3,000/MT for early 2016 delivery.

The rebound upwards in WMP prices from the lows of US$1,500/MT only a few short weeks ago has been spectacular in both speed and extent. The previous large negative for the NZD/USD exchange rate (plummeting dairy prices in May/June that prompted the RBNZ to reverse engines and slash interest rates) that caused the depreciation from 0.7500 to 0.6300 has not only ended but has reversed.

Economists at the RBNZ and the major banks should now be hastily revising their previously pessimistic forecasts for the NZ economy that were based on low dairy prices persisting for some time. At US$3,000/MT, WMP prices are approaching their long-term average levels and provided dairy exporters are locking into the NZD/USD exchange rate below 0.6400, further upwards revisions in the dairy payout forecast seem likely.

It appears that the players in the traded WMP dairy market are anticipating China returning to the market as a large buyer over coming months as their previous Chinese inventory overhang has substantially reduced.

WMP prices may still prove to be volatile going forward as it is not known with any clarity whether Fonterra has already sold withdrawn supply volumes from recent GDT auctions, or whether these volumes are still held in stores.

The appreciation of the NZD against the USD from lows of 0.6240 on 23 September to 0.6385 on 28 September was in the face of a generally stronger US dollar on global currency markets, thus the overall value of the Kiwi dollar, the TWI Index has jumped up to 69.70 from lows of 67.50 in late August. The specific NZ dollar negative, lower dairy commodity prices several months ago that dragged the Kiwi dollar down on its own accord, has now reversed and caused the currency turnaround.

The vast majority of NZ dollar currency forecasters (not this column!) have cited low dairy prices, a stronger US dollar and a weaker AUD on the Chinese economic slowdown as their reasons for the NZD/USD exchange rate to depreciate to below 0.6000. The dairy price negative has disappeared as mentioned above, the remaining two negative forces are debatable:-

  • If the US dollar was going to strengthen further on the widely anticipated upcoming increases in US short-term interest rates by the Federal Reserve, it would have already done so! FX markets price in future economic events and conditions well in advance. The US dollar strengthened from $1.4000 to the current $1.1200 level against the Euro from September last year to March this year in anticipation of US interest rate increases in late 2015. The forecast USD strength has already occurred. The US interest rate increases are already priced-in to the exchange rate, thus significant further USD strength from here seems unlikely.
  • The Australian dollar has also already depreciated significantly against the USD to 0.7000 due to tumbling metal and mining commodity prices as a result of slower Chinese buying demand. Iron ore prices appeared to have hit rock bottom about six months ago, however have not fallen further as prices hold at the cost of extraction. If you believe that that the Chinese monetary and fiscal authorities will let their economy slow to a 2% or 3% GDP growth rate, then mining commodity prices and the AUD can still fall further. However, a more likely scenario is monetary and fiscal stimulus for the Chinese economy to maintain 6% and 7% GDP growth rates and thus hard commodity prices may have already bottomed.

Offshore hedge funds have substantially reduced the number of speculative “short-sold” NZ dollar positions on the Chicago futures exchange from 20,000 a months ago to near zero today. In June 2014 when the NZD/USD peaked at 0.8800 the futures market was 20,000 contracts “long” the NZ dollar. The overseas interest to sell the NZ dollar has evaporated as the forecast lower levels to 0.6000 have just not happened.

Signs of increasing NZ inflation in the September quarter’s CPI numbers on 16 October may prove to be the catalyst that pushes the NZD/USD rate up through its technical resistance at 0.6500.


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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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6 Comments

Didn't Janet Yellen recently fold when it came time to execute a much heralded USD rate hike? And barely an upward nudge for NZD/JPY.

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Why-oh-why do market commentators rely on a one-for-one relationship between the NZD and dairy prices?

A dairy price increase is good news for NZ only if it reflects an increase in demand for our products. But sometimes prices go up because of supply considerations. Like when Fonterra reduces the amount of dairy going to auction.... The fact that prices go up because of a decrease in supply is bad news in this case. This is a signal that Fonterra believes low prices are here to stay for the medium term.

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I hope you are right Roger but I have little faith in it. At today's dairy prices dairy farmers are still way under water and unlikely to increase expenditure significantly. If there is a difference it will be in the level of bank lending required too support the industry. Hopefully you are right however and international dairy prices will ramp up another 20-30% - but I do not believe it. Instead i think that what is likely to happen is that the volumes will rise from the US and Europe and fall from NZ.

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Roger is basically the anti-prediction. Article gives one view, and in days or weeks the market usually shifts the complete other way.

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I've also noticed this.

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These would be the manipulated dairy prices from withholding product?

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