By Roger J Kerr
There will always be an endless debate as to what forces and changes determine the direction and ultimate value of a free-floating exchange rate like the NZ dollar.
The debate is usually centred on whether historical economic and financial market relationships/correlations are the dominant determinants, or whether it is current and anticipated future economic currents that drive capital inflows/outflows and thus currency direction.
Like most things, there is no black or white outcome to this debate; it is a matter of relativity and degree. Relative economic performance of New Zealand compared to other economies that could attract investment dollars in and out of NZ is always a major consideration in forming an exchange rate forward view.
The dominant drivers of the NZ dollar’s value do change over time.
Prior to the 2009 Global Financial Crisis it was the interest rate differential between NZ and US short-term interest rates that played a pivotal role in determining the NZD/USD exchange rate movements.
Super low and stable interest rates over the last six years has meant that the FX markets needed to find other lead indicator for the Kiwi dollar.
The growth of the dairy industry in New Zealand as the method of pastoral farming that provided the highest financial return per hectare from the land has delivered the substitute lead indicator. The price of wholemilk powder (WMP) as our largest commodity export has proven to be the “swing factor” amidst all the economic and financial indicators that go into the melting pot to influence the decisions of buyers and sellers of the NZ dollar. There cannot be any surprise that global hedge funds and speculators who trade the NZ dollar look to the commodity price of our largest export industry as a key determinant of our economic performance, and thus currency value.
The plunge in the Kiwi dollar from 0.75000 to 0.6300 was entirely due to the collapse of WMP prices in June/July.
Over the last two years the reaction of global investors and currency players in the NZ dollar often appears to be a delayed reaction to WMP price movements.
A month ago the WMP price was zooming back up again on the Global Dairy Trade fortnightly auctions as volumes were held back from that sale platform. The NZD/USD exchange rate was bouncing along the bottom at 0.6300 with the vast majority of currency forecasts picking further depreciation to below 0.6000. Exchange rate price action in the NZ dollar over recent weeks has seen a belated recognition by overseas players (in buying the NZD) that the NZ economy was not sliding into recession as many local economic forecasters had boldly predicted. Instead, the return of WMP prices to near US$3,000/MT would mean the NZ economy would still be a relatively top performer in a generally sluggish global economic environment.
Whilst the recovery of the NZD/USD exchange rate to 0.6800 has been impressive, it still appears premature for immediate further appreciation to above 0.7000.
WMP prices can now be expected to consolidate the recent gains at around the USD3,000/MT level as global demand and supply factors even up.
It is hard to see a weaker US dollar on international currency markets driving the NZD/USD rate higher over coming months.
The US Federal Reserve may have delayed their decision to raise their interest rates, however monetary policy is now being loosened further in Europe and China.
After a couple of flirtations towards $1.1400/$1.1500 over recent months the EUR/USD exchange rate seems destined to trade closer to the $1.0500/$1.1000 range in the foreseeable future.
A stronger USD against the EUR does not really allow a continuation of the NZD/USD rate to 0.7000 at this time. A more likely scenario is the NZD/USD rate trading in the 0.6500 to 0.6800 range until such time as the local financial markets determine whether the RBNZ will cut the OCR a fourth time to 2.50%.
The OCR review this week will see no change and it is unlikely that the RBNZ will cut in early December as they are now in “wait and observe” mode with inflation and economic indicators. Latest inferences from the RBNZ are that the NZ economy is stronger in the second half of 2015 than the first half (contrary to their expectations) and significant consumer price increases on imported goods from the much lower currency value over the last 12 months are already underway.
As the NZ economy posts stronger data over coming months and as house prices continue to increase, it would be a brave (or foolhardy!) RBNZ Governor who stimulated the economy even further with more interest rate cuts. Lower mortgage interest rates are the main driver of constantly increasing house prices. Much will depend on inflation and NZD/USD exchange rate outcomes through the next three months. Higher inflation and a stable NZD/USD rate around 0.6500 to 0.6800 may well result in a ruling out of further interest rate cuts.
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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
2 Comments
If the RBNZ does not drop, and the Fed does not raise rates, then I would have thought the NZD would appreciate further, back to 75cents. At that level, unless WMP prices had shot through the roof, deflation here would be near certain. Regardless, even if the NZD stayed where it is, a good part of the depreciation effects of the last 6 months would already be baked in to inflation figures, and as we all know, they remain well below the 2% target. So, if the RBNZ is working to its stated target, and using its really only main tool being the OCR, then I cannot see how they are not dropping rates fairly urgently, as the BNZ pointed out last week.
As it happens I wonder at both the single target and the single tool, but unless Roger is arguing for nudge nudge wink wink ignore both, then interest rates should be coming further down.
If the Fed do eventually raise, and that changes the variables, then the RBNZ could react.
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