By Roger J Kerr
The dramatic reversal and rebound in the NZD/USD exchange rate from lows of 0.7700 last Monday when the consequences of the whey protein contamination were unknown and uncertain, to levels back above 0.8000 is a timely reminder that “event risks” or “shocks” in FX markets sometimes do not last very long and also the direction of the US dollar currency value globally remains a dominant partner in the currency pair.
Local USD exporters who manage their currency risks by using staggered orders down to replace or increase hedging percentages were well rewarded for the management practice and discipline as the Kiwi rebounded upwards within 48 hours.
I would have also expected that Fonterra’s own treasury department would have been busy adding to their NZD/USD hedge book at 0.7700/0.7800 to cement in their 2013/2014 season’s milk solids payout forecast.
The foreign exchange markets quickly concluded that 38 tonnes of maybe contaminated milk product was far from terminal for Fonterra or the NZ economy. The markets rapidly moved onto the next issues of Australian interest rate cuts (fully priced-in beforehand as we expected), Chinese economic data and a weakening US dollar on global FX markets.
Therein lays the next risk to consider for the NZD/USD exchange rate going forward, why has the USD not been able to maintain the gains it made in May when Bernanke signalled that at some point the Federal Reserve would taper back their QE?
My view is that the general USD weakness against the EUR, GBP and JPY last week is very temporary and largely based on the weaker than expected US jobs number of +162,000 the Friday before. To be fair, there has been more positive economic data out of Japan, Europe and the UK of late.
However overall trajectory of the US economy is far superior and USD bulls should not be dissuaded by one month’s employment growth being a little short of expectations. All the other US economic fundamentals for a stronger USD currency remain in place i.e. external trade and fiscal deficits reducing, eventual withdrawal of monetary stimulus and eventual higher interest rates.
The disappointment of the last US jobs result will be quickly forgotten as positive outcomes are expected for US retail sales, manufacturing, industrial production, housing and business confidence data being released later this week.
The Aussie FX market staged a classic “sell the rumour buy the fact” Houdini act last week as following the RBA interest rate cut last Tuesday the AUD appreciated three cents from 0.8900 to 0.9200. As expected, all the bad news was fully priced into the AUD/USD exchange rate beforehand and the short-sold position holders all bought the AUD back when the fact was out. The AUD recovery has pulled the Kiwi dollar back above 0.8000 for the meantime.
I do not expect much impact on the AUD from their upcoming general election as a change of Government with little real change in economic policies is already priced into the FX market. Chinese economic data should improve over the second half of 2013 and already hard commodity prices have stabilised and are starting to recover somewhat. The medium term outlook for the AUD/USD rate is to remain in the 0.9000 to 0.9200 area, which will leave a stable Kiwi dollar in its now established trading range of 0.7700 to 0.8100.
The recent weakness in the USD currency index is not expected to be long-lasting as the US economic prospects and results remain a whole lot better than Europe. The EUR/USD rate trading above $1.3300 again should be temporary. Overall, as the chart below shows, the USD uptrend remains in place with minor volatility around the trend not unusual. The USD Index (currently 81.25) remains on track toward 85.00, which points to a NZD/USD rate below 0.8000.
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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