News and Opinion, sponsored by RaboPlus

By Roger J Kerr

The tight link between the NZD and AUD is slowly breaking down as we anticipated, and as reflected in the NZD/AUD cross-rate falling below previous lows to new 10-year lows of 0.7600.

However the AUD remains the largest single largest influence over the day-to-day NZD/USD movements.

One still has to be confident of the currency outlook that the NZD/USD rate will move lower over coming months as the USD strengthens to 1.3000 against the Euro. However, as I have stated several times over recent weeks, it also requires global commodity prices to be pulling back down to bring the AUD back below 0.9000 and lower.

The jury is still very much out on when and how commodity prices will behave this year after the dramatic spike higher in 2008, the big collapse and then the recovery upwards again last year.

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By Roger J Kerr

It appears to me that there is more to the recent rally downwards in two to five year wholesale swap interest rates than the market just re-assessing and recalibrating of when the RBNZ will lift the OCR this year.

Since early January the three-year swap interest rate has declined from 5.15% to 4.50%.

The extent of this pull-back is telling us that more market participants (large investors and borrowers; not the banks as they are mere intermediaries) are perhaps buying into our view that there will be a paradigm shift downwards in the RBNZ “monetary policy neutral” interest rate from 6.50% to 5.00%.

The comment about the banks being mere intermediaries is not strictly accurate however – these days they are large buyers and holders of liquid securities (e.g. NZ Government Bonds) as they comply with new RBNZ funding ratio regulations.

What this also tells you is that the banks are doing very little new household and business lending; the cash is just piling up on their balance sheets.

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By Roger J Kerr

The trend down in the Kiwi dollar was never going to be a smooth and tidy one given the increased daily volatility that is now the norm in the foreign exchange markets.

The almost daily switching between “risk-on” and “risk-off” in global investment markets is jagging the Kiwi back up again from regular bouts of selling. Hedge funds, bank proprietary FX trading desks and other currency speculators continue to be attracted to buy and sell the AUD (and thus NZD) on these short-term market mood swings.

However, there has been no fresh development to change the medium term view that the NZ dollar is on a major downtrend against the USD that should take it to the mid to low 0.6000’s.

For the meantime, the NZD/USD rate is flicking up and down between 0.6800 and 0.7000 until there is the inevitable build-up in momentum to take it lower.

That downward momentum really has to come from the Australian dollar as all the other drivers of the Kiwi dollar still suggest lower levels (i.e. weaker EUR, the wide interest rate gap to the US and still poor economic performance).

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By Roger J Kerr

Market swap interest rates have rallied lower over recent weeks, reflecting the belated re-assessment by the markets about the timing of OCR increases in 2010 from the RBNZ.

Swap yields may struggle to move a great deal lower from here, but do not expect any lift up for several months either.

The market outlook therefore appears very stable over coming months. Therefore, we have some time available to think about wider relationships between economic growth, inflation and short-term interest rates.

These two charts below support the view that 90-day interest rates may not travel much above 5.00% over coming years:-
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By Roger J Kerr

The lower NZD/AUD cross-rate to 0.7780 does confirm that the Kiwi currency is under-performing the AUD against the USD. However the economic and commodity price news has boosted the AUD once again in the global forex markets to above 0.9000 over recent days, and this in turn is keeping the NZD/USD at 0.7000 for the meantime.

Three conditions occurring together were always necessary for the Kiwi to make a concerted push below 0.7000 to 0.6800 and lower:-

1. A stronger USD against the EUR
This is now very much in train with the EUR weakening from $1.50 to $1.35 over recent months. The economic and investment market outlook in Europe has deteriorated with the Greek sovereign debt crisis highlighting the risks. The EUR/USD exchange rate is headed to $1.30 and $1.25 over coming weeks/months as investment flows and currency traders shy away from Europe.
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By Roger J Kerr

Forward pricing of 90-day interest rates and term swaps rates continues to decline in the marketplace as the realisation sinks in that the economic recovery this year will be slow and bumpy, allowing the RBNZ to take their time in respect to when they start lifting the OCR.

The RBNZ have the luxury of time to wait and observe the economic developments through the first half of 2010 because the NZD/USD exchange rate still remains relatively high (and monetary policy tighter because of this) and banks are paying mile above the OCR for retail deposits, thus actual market interest rates are much higher than the official OCR and BKBM rate settings.

Another good reason why the RBNZ are relaxed about the domestic economy and inflationary risks is that credit growth remains very subdued.

They were starting to be worried late last year when the housing market picked-up, however that has fallen away again and credit growth remains very low.

Given weaker employment, retail and housing data since the early December Monetary Policy Statement, the RBNZ have even more reasons to revert to their dovish tome of their October MPS on the economic forward look and reverse some of their more hawkish (and unnecessary) comments in the December MPS.

If the next Monetary Policy Statement on 11 March reverts to a more dovish tone as we expect, market interest rates could come off another 20 to 30 basis points.
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