By Roger J Kerr
The overall value of the NZ dollar as measured by the Trade Weighted Index (“TWI”) is back above 72.0 again.
The TWI appreciating strongly since the lows of 67.0 in November (see chart below).
When the TWI gets up in the stratosphere near to 75.0 (as it did in early 2008 before the GFC on high NZ interest rates and again mid-2011 on capital flight inflows out of USD and EUR) the economy starts to suffer and it quickly reverses engines. Note the NZ TWI on the chart below (blue line) is inverted on the left hand axis.
Many forces drive the NZ exchange rate direction, one important one is the overall value of the USD itself.
The USD currency Index has been trending upwards since mid last year (red line on chart), however over recent weeks it has come back below 80.0 on the news that the US Federal Reserve will maintain US interest rates at the very low levels until 2014.
Notwithstanding the recent USD Index pull-back, the NZ TWI has diverged away from the general USD direction and again appears over-valued and out of step at levels above 72.0.
The historical negative correlation is reasonably robust with periods of a stronger USD causing a weaker NZ TWI.
Based on superior economic performance of the US over Europe over coming years, my bet is that the USD Index will be heading to 85.0, not 75.0.
Therefore, I do not see the NZ TWI maintaining its current divergent trend above 72.0 and pick it to eventually head back down towards 65.0 at least.
However it will require shocks in global equities and/or Chinese economic news to drive the NZD/USD exchange rate back below 0.8000 in the short-term
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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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