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Roger J Kerr says fears of a global double-dip recession have receded. Your view?

Currencies
Roger J Kerr says fears of a global double-dip recession have receded. Your view?

 By Roger J Kerr

The two-step scenario painted previously for the NZ dollar to depreciate in the short term, however appreciate on higher interest rates and still positive economic fundamentals in the medium term (six to twelve months) appears to be tracking as planned.

A weaker Euro and lower global commodity prices have been two factors behind the concentrated NZD selling seen over this last week, dropping from 0.7900 to 0.7560.

Global investors have certainly lost confidence in the Australian dollar as a safe haven alternative to the Euro over recent weeks.

The Kiwi continues to follow the AUD closely.

Expectation of lower interest rates in Australia due to generally weaker domestic economic data has been one of the reasons for the negative market sentiment against the AUD.

It is not surprising to see the AUD fall away from rates as high as 1.0400 to below 1.0000 against the USD as its major determinant, hard commodity prices, have weakened as global GDP growth forecasts are lowered for 2012.

There is much debate in global financial and investment markets as to whether the forthcoming European economic recession will pull the US and Asian economies down as well. Recent economic data releases in the US would suggest not.

Retail, housing and employment figures have all improved in the US over the last two months, underpinning the stronger US dollar currency trend. Corporate America is also doing rather well with 70% if recent listed-company earnings results being above analysts forecast. US companies have made restructuring cost savings and are now benefiting profit-wise from growing the top-line with improved domestic consumer demand.

Fears of a global double-dip recession have receded, even though there are several commentators who are still preaching the Armageddon outcome.

Amidst this international market and economic back-drop, the NZD/USD exchange rate has weakened as it follows the weaker AUD and EUR exchange rates.

Implications for New Zealand

New Zealand domestic economic data has been a mixed bag over recent weeks.

The Auckland economy appears to be out-performing the rest of New Zealand with Auckland region housing, retail and employment figures all moving positively.

The Reserve Bank will be releasing their prognosis on the economy on 8 December with their Monetary Policy Statement. They will be very careful not to say anything or having anything interpreted by the financial markets that pushes the NZ dollar higher.

The RBNZ know very well that an exchange rate nearer 0.7000 will allow the economy to grow by close to 3.00% in 2012 (exporters expanding), however if the NZD/USD is shunted back above 0.8000 exporters and GDP growth suffer.

The last OCR review statement by the RBNZ stated that interest rates will eventually be increased, resulting in the NZ dollar jumping up two cents. The RBNZ could be well advised to avoid such categorical statements and let the markets work out interest rate changes/timing for themselves.

How low can the NZD/USD rate go on this current downwards trend?

Certainly, a lower Euro exchange rate against the USD to $1.2500 (currently $1.3500) over coming months would weigh the Kiwi dollar down to the 0.7100/0.7200 region. It is hard to see the NZ dollar remaining stable when the USD is gaining against all global currencies.

Given no global double-dip recession and the European debt crisis not deteriorating much further over coming months, the Kiwi dollar should start to find buying support in early 2012 as the markets look forward to increasing NZ interest rates by June.

The RBNZ still have to remove the 2.5% OCR emergency stimulus put in place 2½ years ago at some stage, and by June the evidence will be sufficient of 3.00% GDP growth bringing some inflation risks.

New Zealand still stands out as the only nation increasing interest rates in the second half of 2012 which will lift the international investor interest in the NZ dollar. Already we have seen European fixed interest investment funds being attracted to 4.00% NZ Government bond yields as they sell out of Italian and Spanish Government bonds and are reluctant to accept the very low 1.80% to 2.00% yields available with German Bunds and US Treasury bonds.

Somewhat surprisingly, those investor capital inflows into our Government Bonds have not pushed the NZ dollar higher, or even dented the selling that has taken the Kiwi down to 0.7560.

The NZD/AUD cross-rate has declined from 0.7800 to 0.7600 as the NZD has depreciated at a faster rate than the AUD against the USD over recent weeks.

Perhaps the NZ dollar interbank foreign exchange market is displaying its poor liquidity with down moves exaggerated compared to the larger and more liquid AUD/USD currency markets.

Looking ahead into 2012, the prospect of increasing NZ interest rates and potentially lower Australian interest rates, the resultant substantial closing of the interest rate gap points to a 0.8500 NZD/AUD cross-rate. The NZD appears poised to make major gains against the Yen, Pound and Euro cross-rates as well in 2012 as our interest rates are lifted.

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* 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

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