By Roger J Kerr
International financial and investment market events and developments continue to dominate as the largest influence over the NZ dollar direction against the US dollar in the foreign exchange markets.
The reality is that the NZD and AUD stand out as secure and safe places for global investors to hold funds in times of extreme economic/financial uncertainties in Europe and speculation of further quantitative monetary loosening in the US (printing of additional US dollars, thus its value to decline).
While the Federal Reserve did not decide that further quantitative easing was warranted at this time, the NZ dollar has held onto its gains to 0.7900.
Following the Greek election outcome where the risk of an immediate exit from the European Union and euro was averted with the centre-right political parties cobbling together a Government, global markets were happy to adopt a “risk on” mode or relief rally, which resulted in renewed demand for the growth/commodity currencies (NZD and AUD).
There is, however, a real question whether the bullish tone in international investment markets will remain, with latest manufacturing PMI and ISM data in China, Europe and the US continuing downwards and thus the outlook for global economic growth not as positive.
These global growth uncertainties cap the Kiwi dollar off at 0.8000 for the meantime.
Commodity prices have declined substantially over the last two months in response to a slowing of demand out of China.
The commodity markets have arguably already priced-in the slightly lower global growth scenario.
The NZD/USD declined from 0.8200 to 0.7500 in May due to the falling commodity prices at the time. Those commodity prices are no longer falling and have stabilised over recent weeks.
The commodity markets will see any further easing of monetary policy by the Peoples Bank of China (cutting of official interest rates) as positive for commodities and growth, as Chinese demand will be increased by the monetary stimulus.
Therein lies the major factor supporting the NZD/USD exchange rate value above 0.7500 over coming months, any hint of further slowdown in Chinese demand/economic growth will be countered with monetary stimulus.
Unlike most Western Nations, the Chinese central bank has the firepower to aggressively stimulate demand as they can slash interest rates a long way from current bank lending rates of just above 6%.
In addition to the ability to lift demand by monetary stimulus, the Chinese Government has massive reserves to stimulate fiscally as well, if they have to.
The NZDD/USD is effectively underwritten at 0.7500 because of this situation with China as commodity prices will not be falling if China is pump-priming. The Kiwi dollar will continue to track commodity prices very closely.
Given the above forces underpinning and constraining the Kiwi dollar, the likely trading range over coming months is between 0.7500 and 0.8000.
Wholemilk powder (“WMP”) prices (which are highly correlated to the NZD/USD exchange rate historically) have bounced back up from the sharp decreases seen in the first five months of the year. The latest Fonterra on-line GDT auction confirmed that the 12% price increases in the previous auction were no fluke and the higher prices were sustained.
Fonterra are a major player in the international trade for WMP and it appears that they have deliberately held back supply to the market over recent times to stop the WMP price plummet.
The bounce back up in the WMP prices is very good news for the NZ economy, arguably much more relevant and important than the debt problems of Europe that seem to dominate the financial and business news in the media every day.
Despite the reduction in WMP prices this year, dairy farmers have enjoyed sizeable increases in production, thus rural incomes and spending in heartland New Zealand are in very good shape. The surprisingly strong GDP growth numbers for the March quarter were largely due to increases in primary sector inventories - that is, Fonterra holding back WMP supply from the export market and storing it for longer.
The 1.1% GDP expansion was however broadly based and sent the NZD/USD exchange rate half a cent higher from 0.7950 to above 0.8000 briefly on 21 June.
Looking ahead, the impressive GDP growth in the March quarter means that the NZ economy is on a higher growth trajectory than what most expected at this time.
The end result of higher growth over 2012 is elevated inflation risks earlier than what most imagined, therefore NZ interest rates eventually increasing earlier in 2013 than previously expected.
The net result is a greater probability of the NZ dollar trading well above 0.8000 next year as our interest rates increase and no-one else’s change.
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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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