Roger J Kerr argues it's hard to see the NZ$ plummeting another 10c against the US$ as it has done since mid-July

By Roger J. Kerr

In an unprecedented move last week the Reserve Bank of New Zealand released a special and unscheduled statement on the “unsustainable” and “unjustified” value of the NZ dollar.

The timing and method used was a total surprise to the markets and they reacted immediately by selling the Kiwi dollar down below 0.8000 to the USD. The jawboning to depreciate the currency was spectacularly successful and the market reaction is exactly what the RBNZ would have wanted to see beforehand.

The NZD/USD exchange rate plummeted from 0.8070 on Thursday 25th September to a low of 0.7918 on that day’s trading. Selling of the currency continued on Friday 26th September and the Kiwi dollar closed on its lows in New York trading at 0.7860. The Trade Weighted Index has reduced by 6.5% from this year’s highs of 82.03 to 76.64.

As to why the RBNZ would suddenly decide to go outside the norm in respect to monetary policy management at this time and communicate to all and sundry by a media release is perhaps explained by two factors:-

• They have clearly waited until the New Zealand general election was out of the way, such an important directive on the exchange rate could not have been made before the election.

• Governor Wheeler has been patiently waiting over the last 12 to 18 months for the US dollar to start strengthening so that any jawboning or overt intervention to sell the NZ dollar would be effective and achieve its objective. Over recent weeks the US dollar has recorded strong gains as the global FX markets start to price-in rising US interest rates in 2015. There was no point in the RBNZ cajoling the NZ down up until recent months as the US dollar was still going across the page on the chart.

The RBNZ’s statement and accompanying analysis paper highlighted the fact that the “real” value of the NZ dollar was at 120 on its Index, well above the 50-year equilibrium average of 95. The major point the RBNZ was making was that the high NZ dollar value was no longer warranted as the economy’s fundamentals had substantially weakened with the 45% plunge in Wholemilk Powder prices since March.

The forex markets have already been marking the Kiwi dollar down based on the lower dairy prices. However, to be fair, the opportunity for the Kiwi dollar to be sold aggressively has only been available since late July when the RBNZ themselves flip-flopped and paused future interest rate increases after pushing interest rates upwards (and the NZD higher) in early June with a hawkish monetary policy statement.

Whilst this latest RBNZ currency modelling and analysis is all fine and dandy in theory, the reality is that exchange rates are “relative” prices. New Zealand’s economic fundamentals may well be substantially weaker than six months ago, however the European and Japanese economies have retreated over this period despite massive monetary stimulus.

A higher NZ dollar on the cross-rates to the Euro and Yen would seem fully justified even though the commodity price of our major export has dropped alarmingly. What was not fully explained in the RBNZ statement is the reality that once Wholemilk Powder prices stabilise and recover, New Zealand still has much higher interest rates at 3.50-% to 4.00% than most western economies.

For this reason it is hard to see the NZ dollar plummeting another 10 cents against the USD from the 10 cent nose-dive since 0.8830 in mid-July. The US dollar itself has reached a major resistance point at 85.60 on its Index and may need to consolidate in its recent gains before it can push on to higher levels. It may be somewhat early to call a similar stabilising period for the NZD/USD rate in the 0.7700 to 0.7900 range, however this appears more likely than a continuation down the elevator shaft to 0.7500 over coming weeks.

There was nothing new or too enlightening in the RBNZ statement last week, the FX markets were already well aware of the crash in dairy prices. However, it does make a difference when the central bank highlights the misalignment between the currency value and the economic fundamentals. The sharply lower Kiwi dollar is good news for the economy with manufacturing exporters having adjusted their business models to a 0.8000 exchange rate.

Most importers (except the oil companies) are hedged further forward than normal, thus inflationary impacts from the currency depreciation will be muted and delayed on this cycle.

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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