By Roger J Kerr
The standout feature of global currency markets over recent weeks has been the increase in geo-political tensions surrounding Syria and North Korea, resulting in a general “flight to safety and safe haven” assets by investors.
The Japanese Yen always strengthens in these conditions and on cue it has shifted from 114.00 against the US dollar to below 109.00 as Japanese investors repatriate funds home (buying Yen to do so).
Another sign of safe haven flows is the weight of money coming into US Treasury Bonds, the 10-year yield being forced down from 2.40% to 2.25% over the last three weeks.
The international sabre-rattling and brinkmanship coming from the new Trump administration on the geo-political stage is not totally surprising, however it is another example of a pre-election pledge of the US not being the world’s policeman being totally contradicted.
The inability of the North Korean regime to follow through on their threats is likely to result in the current geo-political risks and uncertainties reducing in intensity over coming weeks. Therefore, an unwinding of the current Yen and US Treasury Bond strength is more likely than continued gains. The Japanese Yen/NZ dollar cross-rate at 76.20 offers excellent long-term hedging opportunities for local Yen exporters, as outside the short-term safe haven investment flows there is no economic justification for the Yen to be stronger against the US dollar. A return of the JPY/USD rate to 114.00, crossed with a 0.7100 NZD/USD exchange rate would have the JPY/NZD cross-rate back above 80.00.
Over our history, successive European and US leaders have failed to find peaceful or political solutions to the ongoing troubles and injustices in the Middle East and Afghanistan. The current bunch will not have the answers either. Over coming weeks the worries that financial and investment markets have displayed about global geo-political risks should subside and the focus of attention will return to underlying economics and relative values.
Against this scenario, the New Zealand dollar does not stand out as a currency that will draw attention to be actively purchased or sold by offshore hedge funds and/or currency speculators. Whilst general investment and financial markets have become more volatile as geo-political tensions increase, and the unpredictable and aggressive behaviour of US President Donald Trump adds to the mix, the NZ dollar has held its own and remained in the tight 0.6900 to 0.7100 trading range since the start of March.
It is instructive as to the much reduced international interest to play in the Kiwi dollar that the NZ dollar has not been sold lower over a time when the VIX market volatility index has shot up on these global tensions. Typically, the historical correlation of the Kiwi dollar to the VIX index would have seen a much lower NZ exchange rate. The NZD/USD rate has bounced off the support line of 0.6900 on three separate occasions over the last six weeks, indicating the Kiwi’s stability and resilience that this column had expected through this period.
A number of factors point to the NZD/USD rate remaining comfortably above 0.7000 over coming weeks and months:-
- Dairy commodity prices have reversed engines again and are now trending back up as adverse climatic conditions in New Zealand limit late dairy season supply volumes. Whole milk powder futures prices are back above US$3,150/MT and another GDT auction this week will confirm the price improvement. An abundance of grass throughout New Zealand is keeping livestock on the land for longer and therefore forcing up sheepmeat and beef prices in the marketplace. The overall commodity price index is moving sharply higher and suggests a NZD/USD rate above 0.7200, rather than 0.7000.
- The CPI inflation increase for the March quarter released on Thursday 20 April could easily be more than the +0.7% consensus forecasts. A number closer to +0.9% due to food price increases would be interpreted as positive for the Kiwi dollar as it would bring forward the timing of when the markets are pricing the first RBNZ OCR hike in 2018.
- The Australian dollar has completed its much needed correction down from 0.7700 to 0.7500 against the US dollar as metal and mining commodity prices unwound (fell) from the Trump reflation rally. A stabilising of mining prices, partially due to Australian supply disruptions as a result of the cyclones, coupled with stronger Aussie employment data has returned the AUD/USD exchange rate to 0.7580. Stronger than expected Chinese GDP growth figures are also a positive for the Aussie dollar, therefore expect to see the NZD/USD rate dragged upwards by the AUD/USD rate moving back above 0.7600.
Despite the above mentioned positives and a still high-performing NZ economy, there is not a strong argument for the Kiwi dollar to appreciate back to 0.7400/0.7500 against the USD at this time. The US dollar itself is highly unlikely to weaken against the major currencies when the US is increasing interest rates and the rest of the world is not. A stable to stronger USD against the Euro, Pound and Yen over coming months will cap and limit NZD gains to around the 0.7200 mark. The NZD/AUD cross-rate should hold in the 0.9200 to 0.9300 range as the two currencies move in tandem against the US dollar and the respective Aussie and NZ commodity prices no longer diverge in direction.
Roger J Kerr contracts to PwC in the treasury advisory area. 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