Roger J Kerr says speculation on both the NZ and Australian currencies is back in vogue

By Roger J Kerr

International investment and speculative flows continue to dominate the day-to-day direction of the NZD/USD exchange rate.

The RBNZ’s review of the OCR interest rate this Thursday, April 28, may see a return to domestic forces having an influence. The Kiwi dollar reached a high of 0.7050 on 19 April, largely following a stronger AUD on global FX markets against the USD. Another surge upwards in commodity prices lifted the AUD/USD to above 0.7800. However, the gains by the antipodean currencies could not be sustained and the NZD/USD has reversed back down two cents to 0.6840 over recent days. The AUD has not reversed direction as far as the Kiwi, only down one cent to 0.7700, therefore the NZD has lost further ground against the AUD on the NZD/AUD cross-rate to 0.8880.

Over recent weeks the gains in the NZD and AUD appear to have come from two speculative sources as investors and punters in all parts of the world desperately seek out some sort of positive return from the financial and investment markets. Zero interest rates in many economies and overheated equity markets are causing these investment/speculative selections and thus short-term capital inflows into the Australasian currencies as this time.

• The “carry-trade” investments are back in vogue whereby hedge funds and fund managers borrow a low interest rate currency and invest in a higher yielding currency. The NZD and AUD do offer 2% yield return advantage compared to other currencies, plus a currency gain if the flows are sufficiently substantial into the carry trade to cause the purchased currency to appreciate. Carry-trade flow data measured by Deutsche Bank has volumes in these trades over recent months returning to pre-GFC levels. The sharp pull-back in the NZD/USD rate from highs of 0.7050 last week to 0.6840 suggests that the smart money is already taking profits on their NZD carry trades and thus selling out of the Kiwi.
• It seems that Chinese retail “investors” have moved on from punting the Shanghai stock market to leveraged speculation in commodity markets. The speculative volumes and pressure to buy commodities on futures markets has caused the recent lift in most commodity prices at a time when global industrial demand for the physical commodities has definitely not increased and global supply has not reduced either. Again, hedge funds and fund managers have ridden on the back of these market surges as they also seek out some investment return. Many commodity speculators buy the AUD currency as a proxy for commodity prices as they know it will follow the movements of commodity prices generally. Off course, the rally upwards in prices cannot be sustainable if the underlying and fundamental supply/demand equation has not altered. The gains in commodity markets appears already to be very short-lived. As commodity prices shift back down again, both the NZD and AUD should give back most of their recent gains.

The local New Zealand interest rate market pricing is far from convinced that the RBNZ will cut the OCR again on Thursday, only pricing in a 30% probability. Bank economist prior predictions are evenly split.

The pressure is on the RBNZ as Governor Wheeler has stated that the lack of depreciation in the NZ dollar is contributing to annual inflation remaining lower than they require to meet their 1% to 3% target band.

Since the last OCR cut in early March, which was designed to push the NZD down, the Kiwi dollar has appreciated from 0.6500 to 0.7000! At that time the RBNZ stated that further interest rate reductions were likely. Why would the RBNZ wait a few more months before cutting the official interest rates when the inflation outcome for the March quarter was in line with their forecasts and the currency is much higher? In many respects reducing interest rates again at this time is the lesser of two evils as the subsequent decrease in mortgage lending interest rates will only pour more fuel onto the residential property market fire.

The RBNZ should cut rates to get the NZD down to immediately assist the beleaguered dairy sector and hope that further macro-prudential measures and Government actions control the real estate bubble. Governor Wheeler will know only too well that if he pontificates this week and does not cut the OCR, the NZ dollar will move back up above 0.7000 again and he will be under even more pressure and scrutiny with inflation staying below the 1% minimum for longer.

This column has been consistent with the view over recent months that the only justification for further OCR cuts would be if the NZD/USD exchange rate increased to 0.6900/0.7000. That has happened and now the RBNZ need to be consistent, not flip-floppy, in their signalling and actions.

The expected cut in the OCR this week, coupled with the USD itself starting to recover against the Euro and Yen on global FX markets should deliver further NZD selling and a return to the 0.6500/0.6600 region.

Over the last 12 months the EUR/USD exchange rate has been pushed to $1.1400 on two previous occasions when the markets have sought safe-havens away from the US dollar on equity market falls.

The latest Euro strength/USD weakness to $1.1400 has been based on Federal Reserve Chair Janet Yellen adopting a super-cautious and very slow strategy on further increases in US interest rates. The previous Euro gains to $1.1400 have failed and the EUR/USD rate has returned back to the $1.0800 area. It appears that this third push has also failed with the EUR/USD rate back to $1.1260 over recent days.

There is no economic sense in the Euro strengthening against the USD when Europe has no inflation and no growth, whereas the US economy has growth and core inflation both above 2%. It may take a few months of positive US economic data and stable equity markets to convince Janet Yellen to lift US interest rates again. However, the FX markets always price the future well in advance, therefore further USD gains to $1.0800 seem likely over coming weeks.

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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