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Roger Kerr ponders the mysteries of currency markets and why the NZD isn't falling as dairy prices sink. Your view?

Currencies
Roger Kerr ponders the mysteries of currency markets and why the NZD isn't falling as dairy prices sink. Your view?

 By Roger J Kerr

The Kiwi dollar just will just not lie down and depreciate as most of its lead-indicators suggest it should.

While foreign exchange markets may be misunderstood, perverse and illogical in how they respond to economic news, the reality is that consistently build in the future well in advance and often do not react as the majority would expect.

In most cases, how speculative trades are positioned (long or short the currency) determines the rate movement post significant economic announcements.

The lack of NZD selling in the FX markets after the substantial decreases in international wholemilk powder (WMP) prices and other NZ commodity prices over recent times is an example of one of those currency market mysteries.

The historical correlation between WMP and the NZD/USD exchange rate has been a high one, until the dislocation over recent months.

While it appears that the NZ dollar has temporarily de-linked from its fundamental commodity price drivers, the arguments are not strong that the NZ dollar will now trade independently and opposite of the agriculture commodity prices the NZ economy depends on. A NZ dollar catch-up to the fall in WMP appears inevitable; however there is no sign of it yet.

In the short-term the issue come back to market positioning, the NZD speculators were already holding “short NZD” positions when the last Fonterra/GDT on-line auction price for WMP dropped sharply. There were no more punters prepared to take new short sold positions on top of what was already in place and when the NZD/USD rate failed to fall below the key 200-day moving average at 0.8080, the short-sold position holders brought their NZD’s back.

Not even the explicit “jawboning” down of the NZ dollar by the Governor of the Reserve Bank of New Zealand and the Prime Minister in recent weeks has convinced the markets to take on net new “short-sold” NZD positions.

Rightly or wrongly for New Zealand’s current economic situation, the rest of the world does see our overall economic health and outlook as more positive than most other countries and as exchange rates are relative prices, relative to elsewhere we still appear attractive as an investment destination.

It is very apparent that we are seen as a currency that is safe and secure when there is such much uncertainty in the world as to the direction of all the major currencies, including the USD, Euro and Japanese Yen. Lower milk powder prices and jawboning down by officials have to date not been a sufficient enough catalyst yet to drive the Kiwi dollar below 0.8000 into the 0.7000’s. On the other hand, there have been no positives to push the NZD upwards.

One explanation of why the NZD was not sold lower following Governor Bollard’s threat to cut interest rates if the NZD did not depreciate, was that lower interest rates would further stimulate the domestic economy and that would eventually lead to stronger GDP growth, increased inflation risks and the RBNZ being forced to inevitably raise interest rates, which is positive for the NZ dollar.

There was also the case that the market did not really believe the RBNZ would cut interest rates with the economy expanding 3% this year and thus if threats are not expected to be delivered on, they are hollow and meaningless.

As has been observed in recent days, it is not New Zealand’s economic drivers and performance that solely determines the NZD/USD exchange rate direction.

A marginally weaker than expected US GDP growth number for the March quarter caused USD selling against all the major currencies as looser US monetary conditions for longer was the market’s short term conclusion. The growth/interest rate connection stimulated Wall Street to make gains (super low US interest rates being positive for shares) and the Kiwi dollar continues to track the Dow Jones Index. Stronger US economic data over coming months should be positive for the US dollar and negative for the US sharemarket (the support of super low interest rates eventually coming to an end), both of which should pull the NZ dollar downwards.

Lower Australian interest rates and potentially weaker Chinese economic data this week will be the focus of the currency markets. Performances of Manufacturing Indices in China are currently providing mixed results, however the AUD in particular remains vulnerable to weaker Chinese economic data. The NZD/AUD cross-rate is now lifting towards 0.8000 (albeit in jagged fashion) as Australian interest rates decrease and NZ interest rate move no lower.

The interest rate gap between the two currencies is reducing and this points to further increases in the cross-rate towards 0.8300/0.8400 over the next 12 months.

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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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