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Roger J Kerr says the Kiwi dollar is caught in the crossfire of US investors retreating to home base

Roger J Kerr says the Kiwi dollar is caught in the crossfire of US investors retreating to home base

Assessing and projecting how exchange rate values may change as a result of market and economic trends/swings is nigh impossible in the current environment as we experience an unprecedented stop in economic activity around the world.

It is not possible to have any accuracy in estimating how long and how deep the economic downturn will run.

No-one can forecast with any confidence about anything.

Alternative scenarios are published; however, these are changing daily as events unfold. Economic, investment and business news that normally influences the direction of free-floating exchange rates have been swamped out by reactive/panic decisions by global fund managers to return their money immediately back to home base.

The Kiwi dollar was caught in the crossfire of this frenzy last week as US investors, in particular, sold out of foreign equity and bond holdings in a mad scramble to return their funds to US dollars - the fund managers requiring the US dollars to meet their own margin calls and client fund redemptions. Foreign participation in our bond and equity markets has generally been a positive thing in the past, however it does leave the currency vulnerable to wholesale disinvestment in global shocks that are nothing to do with New Zealand.

Whip-sawing price action in wild and dysfunctional FX markets

Large scale sell orders on the Kiwi dollar to buy US dollars were unable to be met in the forex market over this last week, resulting in a second “flash-crash” in the NZD/USD rate from 0.5950 to 0.5480 on 19 March; illiquid market conditions and a total absence of NZD buyers created the free-fall situation. Since that plummet in the rate on 19 March, the Kiwi dollar has whip-sawed up and down between 0.5500 and 0.5900, finally displaying signs of settling around 0.5700. The USD has continued to strengthen against the major EUR, GBP and JPY currencies as share markets collapse and US fund managers disinvest their offshore assets to shore-up their home positions.

The global shortage of US dollars last week due to the aforementioned demand, prompted the US Federal Reserve to provide currency swap facilities with other central banks around the world, including the RBNZ.

The speed of the NZ dollar depreciation raised the spectre of whether the RBNZ would be considering direct FX market intervention to stabilise the NZ dollar in disorderly and dysfunctional market conditions. It is a high threshold or hurdle to intervene, the criteria or prerequisites being:-

  • The NZ dollar currency value must be exceptionally high or low.
  • The exchange rate level must be unjustified by economic fundamentals.
  • Intervention must be consistent with the RBNZ’s Policy Target Agreement.
  • Conditions in the FX market must be opportune and allow intervention a reasonable chance of success.

While the RBNZ would have been monitoring the markets last week, it is doubtful that all four pre-conditions for intervention would have been fulfilled.

In my view, the NZD/USD rate would need to be trading below 0.5000 to meet the first and second prerequisites. However, the pressure is on the RBNZ to intervene in the local interest rate/bank funding markets ASAP as long-term interest rates increase (due to more Government bond issuance and absence of foreign buyers), a perverse outcome when the OCR was slashed 0.75% to reduce interest rates across the yield curve.

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When and how will Government fiscal rescue packages work?

Australia is about the announce their second and much larger Government fiscal package, the US is set to announce a US$2 trillion aid deal/relief package and Germany is considering a US$380 billion in new debt to fight the coronavirus crisis. However, in terms of potential impact on the NZ dollar value, we await the size and scale of the inevitable Chinese Government fiscal package. The Chinese saved the global economy in 2010 with massive infrastructure spending and they will do the same again as a global recession decimates their manufactured exports. After plunging to 0.5000 during the GFC in 2009 (refer chart below), the NZD/USD exchange rate reversed sharply higher in 2010 to 0.7500 as commodity prices soared (higher AUD) from the Chinese demand for raw materials/commodities.

The chance or probability of China implementing the same policy in 2020? – much greater than 50% in the viewpoint of the author.

Short-term demand for USD’s will run out, and then what?

Whilst the mad scramble for the US dollar has strengthened the rate to $1.0700 against the Euro over the short-term, the medium-term outlook for the US unit is set for a serious depreciation for the following reasons:-

  • The US economy will potentially be hit harder than others, requiring large-scale Fed Quantitative Easing – a major US currency negative.
  • The increased size of the US internal budget deficit and Government debt levels.
  • An over-valued USD is extremely damaging to the global economy as emerging market economies struggle to keep afloat.
  • Coordinated central bank FX market intervention to weaken the US dollar is very much on the cards as another mechanism to return confidence and growth in the aftermath of the virus shock.

The NZD/USD exchange rate will not remain at these lower levels if and when the US dollar depreciates for the above reasons.

NZ exporter profitability key for economic recovery

The rapid NZD depreciation to 0.5700, without the typically related large decreases in our key export commodity prices,  provides a rare opportunity for our primary industry exporters to hedge forward USD receipts and lock-in significant profit margins. Increased business Investment and jobs in our economy come from increased and secure future profits. Many USD exporters have already hedged forward in the low 0.6000’s, however they now need the support of their bankers to provide the FX dealing limits to hedge even larger amounts further forward. When the Kiwi dollar was at 0.5000 in 2009 many exporters at that time wanted to hedge large volumes, however they were restricted from doing so due to their bankers being overly worried about the unrealised marked-to-market losses on existing FX contracts. The Government and Adrian Orr at the RBNZ are asking the banks to be supportive of business in these challenging times. Providing the facilities for companies to secure their future profits through prudent FX hedging is one way the banks can help the economy recover.

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*Roger J Kerr is Executive Chairman of Barrington Treasury Services NZ Limited. He has written commentaries on the NZ dollar since 1981. 

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Pretty interesting commentary is all I can say.

Personally think the RBNZ will be praying that the Kiwi is closer to 40 vs. 50 cents in the coming months given the news. Oil now sub 20 a barrel and maybe heading down to 15 or even 10?

That will unleash a deflationary wave and accordingly RBNZ will want the currency to weaken further to 1. Create an inflationary pluse and 2. Increase exporting income to support our industries/country moving forward.

When we start to see some positive news - Kiwi will sky-rocket, but given this is a health crisis - that's unlikely till months away - and even more importantly, given the state of economy post crisis - my money is that the RBNZ will want a weakened Kiwi for a long time to assist in the recovery.

Sounds reasonable. But that Infaltionary Impulse you mention - that's probably the last thing the NZ economy needs in a weakened state.
Look to Japan for what's more likely - spending stops. Habits are going to be changed during this crisis. People will remember how close they personally got to the edge; how the supermarket shelves were ravaged; how job insecurity stared them in the face, and they are going to save, save, save - just in case it happens again.

What happens if there's a bank run and peoples savings get wiped out? Will that be the incentive to save, save, save?

Savings aren't going to get wiped out. Can you imagine what kind of Financial System New Zealand would have if that was allowed to happen? None.
IF RBNZ accredited banks run into trouble they will be merged with other, larger ones, that can absorb them. If that fails ( and in the highly unlikely event that the Aussie parents cut their subsidiaries loose) the RBNZ will take them onto their balance sheet - nationalise them and New Zealanders' deposits.
It's what we see about us today. the RBNZ doing what it has to do ( albeit futile!) and that will continue.
Your savings are safe.

With or without the OBR haircut first?

Remember if you get a wave of deflation on assets - thinking house prices and other assets - unless Banks are prepared to write down the value of their loans - you could potentially create a downward spiral for anyone holding an assets, with leverage over it.

Delicate balancing act for the RBNZ is to ensure that we don't fall into outright deflation but also ensure that inflation is kept within their target of 2-3% - they will be earning their salaries over the next couple months I would imagine.

Any thoughts on what will happen to NZD if property market starts to tank? If those who purchased prior to foreigner buyer ban implemented sell, could we see another drop?

IO, why are you in such a good mood at the moment?
It is good that you are a bearer of good thoughts.
The housing market throughout NZ is not going to tank.Yes , less activity but if anything the market is going to be stronger for this as many will see that housing is the safest and best investment.

Have you had a chat to some of the property owners in your neck of the woods and Kaikoura, who are yet to be compensated for the damage to their 'safest and best' of all investments?
Property, in the best of times, is a good investment to hold and could be part of anyone's portfolio.
But during the worst of times (now?) it's right up there with the last thing you'd want to hold. But hold it people will, and hold and hold and hold...Because in 10 years, we'll be back to where we were! Right?

Just exploring possibilities TM2 and seeing what other peoples thoughts are so I can better my understanding of what might be to come.

I agree with Grant. Until the 80's the NZ economy was pulled along by one OX. In the past 40 years that has changed to a much bigger cart pulled by 2 oxen---and one those has been gored. Given reports overseas in the US that by the end of last week 39% of wage earners when surveyed were on reduced wages or laid off I think the tsunami of income wipe outs for our 500,000 small business employers (farmers excepted) will be devastating.
If the true nature of the final US aid package is projected to be $5 Trillion before its all over I cannot foresee a situation in which the skies fill up with travelers heading to NZ for some time to come.
Nor is the NZ Treasury able to borrow with impunity to get its citizen's through the next 12 months without a major hit to the KIWI. Yes it did stop at only 50 cents in 2009--but I think the 2000 period should now be reviewed further. What caused to Kiwi to drop to 39 cents in October 2000?

Dangerous article in my opinion. China will print money in their own currency and swap the rest of the world for hard commodities with it like they did to 'save the world' in '08. Let's see how that goes. Summary or Rogers articles over the last two years;

NZ Dollar will rise against all other currencies including gold at all times under all circumstances and will be global reserve currency before too long.

Reality is that there's every chance it will have a 3 in front of it against the USD before too long.

Nigh impossible? Not at all. At least for the next month revisiting the low 50's (1NZ$ buys US$0.50 - 0.55c) as during 2009 is not an unlikely target. Or into the mid to low 40s (as per 2001 exchange rate) is a second target area given 3 to 4 months. Yes, I could be wrong...just like Roger has been for so long!