By Roger J Kerr Further large-scale NZD depreciation by no means assured The expectation prior to Christmas last year was that the NZD/USD exchange rate would be less volatile and trade within narrower ranges in early 2009. How wrong that view has been! The Kiwi had a brief flurry above 0.6000 early in the New Year, but has since been sold heavily in the market to a low of 0.5280 last week. The wild swings have been partly due to AUD/international currency movements, but very weak economic reports here in New Zealand have added a large dose of local negative factors onto the currency as well. From highs of 0.5900 at the start of last week, the Kiwi was dumped 6 cents in five trading days last week to below 0.5300, as the market took fright from two important economic announcements:-

The NZIER Quarterly Survey of Business Opinion turned very ugly with business confidence, profits and employment expectations all plummeting to record lows. Business firm's pricing intentions were also lower, adding to the downward momentum of local interest rates. Capacity utilisation was down from 90 to 88, alleviating any medium-term inflation pressures. The very low level of confidence convinced the markets that the NZ economy would contract further in 2009 and the recession would be deeper and extended in time. The results of this survey were worse than expected, but perhaps something of an over-reaction by survey participants on the downside. This QSBO survey is not representative of the NZ economy as a whole as the agricultural sector is excluded. It reflects the severe problems in the building/property, finance and retail sectors. Credit rating agency Standard & Poor's finally recognised that New Zealand now has a dual-deficit situation and put the NZ Government's AA+ foreign debt credit rating on credit-watch "negative". Over the recent boom years whilst the Government was recording internal budget surpluses, S & P saw this as off-setting the structural/permanent external Current Account deficits. The implications for foreign investors into New Zealand are negative, thus the Kiwi dollar was sold swiftly down on the S & P news. However, the NZ Government's small amount of foreign currency debt is matched by deposits of equal amount. The direct implications are not that great. The real negative factor from the S & P report was that New Zealand has limited flexibility and economic policy options to turn these dual-deficits around. Adding to the downward momentum on the Kiwi was a stronger USD (as the Europeans belatedly slashed their interest rates and the Euro weakened) and a continuing closing of the interest rate gap between US and NZ 90-day interest rates. Several local bank economists and other currency forecasters are predicting the NZD/USD rate to fall further to 0.4500/0.4000 in 2009. The large Current Account deficit at 8% of GDP is the main driver of the still weaker currency outlook. Having already depreciated 30 cents from 0.80 to 0.50, a further 10 cent fall will require actual capital outflows and disinvestment from New Zealand. The rebound upwards from the lows of 0.5280 to the current 0.5480 last Friday was an indication that much of the recent Kiwi selling was speculative in nature and not portfolio investment monies departing New Zealand. The Kiwi rebounded two cents upwards on market profit-taking. The vast majority of foreign investors who were previously in New Zealand attracted by the previous high yields have long departed with their money. There is little in the way of foreign portfolio investment amounts left here to be sold. For the Kiwi to be sold down to 0.4500 and below there will need to be major capital flows outwards, and their does not appear to be the overseas funds still in New Zealand to cause that large outflow. For this reason the NZD/USD exchange rate is more likely to trade "in the 0.5000's" over coming months than to depreciate below 0.5000. Another important driver of the NZD value from day-to-day is the US sharemarket movements as measured by the Dow Jones Index and sharemarket volatility measured by the VIX Index on the S & P 500 share index. The NZD/USD is strongly correlated to these indices. Foreign investors increase their risk aversion when the DJI falls and automatically reduce their market exposures to tin-pot South Pacific currencies at the same time. When they decrease their risk aversion as the DJI rises and volatility reduces, the Kiwi is not sold and may find some friends. A stabilising US sharemarket around 8,500 on the Dow Jones Index should keep the Kiwi in the mid-0.5000's area. The outlook for the NZ dollar can only turn to a more positive tone when the economy displays signs of recovery. The timing of the export-led recovery remains totally dependent upon our export commodity prices. Up until December the key lamb, beef and dairy commodity prices were still falling. However there are more recent signs of the prices stabilising. It may take until the latter part of 2009, but at some stage the Kiwi dollar will reflect the NZ economy coming out of recession well ahead of others as our position as a food exporter is realised. * Roger J Kerr runs Asia Pacific Risk Management. 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.