Roger J Kerr says at some point the FX markets will realise it is premature for the Australian currency to be strengthening

By Roger J Kerr

Important determinants of the NZD/USD exchange rate direction from 0.6900 in the short to medium term are based around the following questions and themes:-

• How far oil and hard commodity prices decrease (thus depreciating the AUD against the USD) following the non-agreement by OPEC to freeze oil production over the weekend. The Kiwi dollar would follow the AUD down?
• How the FX markets react to a NZ CPI inflation result for the March quarter of +0.20%, which was bang on the RBNZ’s forecast?
• Whether the RBNZ cut the OCR again on 28 April as the exchange rate has remained at elevated levels over the past month well above their expectations?
• Whether the current patience being shown by all the banks’ lending to the dairy sector continues as the latest currency gains independent of Wholemilk Powder prices (which continue to bump along the bottom) places further downward pressure on dairy farming incomes.
• How the global FX markets react to the Australian Federal Budget on May 3 wherein Treasurer Scot Morrison is set to announce fiscal deficits over coming years well above prior expectations?

So many of these questions revolve around Australia and their dollar.

The AUD/USD exchange rate raced up from below 0.7000 in January to 0.7700 last week on the back of the spectacular rally upwards in metal and mining commodity prices.

The increase in commodity prices appears to be totally speculative positioning by financial players as they seek a return outside equities and bond markets. Global economic demand and supply has not changed for iron ore, aluminum and copper, therefore the price increase cannot be sustainable.

Now that the OPEC oil production/price meeting in Doha has ended in disarray with Iran not showing up, oil prices should recoil back most of the 20% increase the have posted in recent weeks. Expect commodity prices and the Aussie dollar to follow oil downwards.

Two years ago the AUD was slammed down hard when the size of their Government Budget deficit turned out to be well above the number anticipated by financial markets.

Australia has struggled to reduce its Government debt levels since the GFC and successive budgets that project fiscal deficits over AUD40 billion over coming years do not help their numbers. The credit rating agencies will be looking hard at these unacceptable Aussie financial health trends and at some point the FX markets will realise that it is far too premature for the AUD to be strengthening.

Locally, the inflation result has turned out to be a non-event for the currency markets.

It appears that the only force that can pull the NZD/USD rate back to the 0.6500/0.6600 region is serious selling of the AUD and we follow.

Banks’ lending to the dairy sector will be waiting for the new season’s milksolids payout forecast from Fonterra at the end of May before deciding on their next steps with delinquent borrowers. One potential large and scary negative for the NZ economy and the NZ dollar value is media headlines in June/July on widespread bank foreclosures on dairy farm borrowers. We all hope that the milk price will improve and the banks do not take that hard line, however the aforementioned risk must be starting to increase.

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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