By Roger J Kerr
The biggest question in front of local organisations with NZ dollar foreign exchange exposures right now is whether the global FX markets have already fully priced-in a substantially weaker USD as a result of the third quantitative monetary easing ('QE3') by the US Federal Reserve.
The USD weakened against all currencies ahead of the Fed’s QE3 decision last week to introduce the open-ended bond buying programme and injection of more USD’s into their banking system (printing of USD’s).
Now that the fact is out, we may well be witnessing a classic “sell the rumour, buy the fact” market situation as far as the USD currency value is concerned.
The USD has depreciated against all currencies with the overall USD Index dropping from the 81 area to below 79. The NZD/USD exchange rate reached a high of 0.8350 on Friday 14 September; however it has since pulled back to 0.8290.
All the NZD buying by speculators wanting to be out of USD’s may have already taken place and it has to be expected that now that QE3 factor is been and gone, the forex markets will look forward to the next determinant.
It seems both remarkable and outrageous that the Euro has strengthened so much against the USD from $1.2200 to $1.3100 over this past month when the European-wide economy is in recession and the ECB is also buying bonds and about to cut interest rates again.
It seems that that all the major economies and currencies are in a monetary loosening race to the bottom of the cliff without regard for the consequences.
Being a tiny, but totally free-floating exchange rate, the Kiwi dollar is being caught in the backwash of these global economic/market torrents.
The EUR gains to $1.3100 also appear to be due to the unwinding and reversal of capital flows that left Europe in May and June when the Spanish debt/bank problems blew up. As has been the case for almost three years now, the European economic and debt problems have not been miraculously solved by periodic political statements of intent, and eventually about every six months the markets become frustrated and start selling their Government bonds again in an attempt to force more fundamental economic policy change.
The last market attack was in May and June resulting in the Euro currency weakening to $1.2200. There appears a reasonable probability that the financial and investment markets will lose patience with current European economic reform progress again before the end of the year and the Euro will weaken.
A 7% fall in the EUR/USD rate back to $1.2200 over coming months would pull the NZD/USD rate back to the 0.7700 area if the NZD tracked the EUR against the USD.
Off course, in the May/June sell-off of the Euro the NZD was seen as a safe haven alternative currency and investment destination and did not depreciate with the Euro, resulting the NZD/EUR cross-rate jumping to above 0.6600.
However, the attraction of the AUD and thus NZD as safe-havens from Europe’s risks may have changed dramatically in the last two months. The de-coupling of the AUD/USD exchange rate from hard commodity prices that drive the Australian economy is a significant negative economic development for Australia. Add on the increasing probability of a Reserve Bank of Australia interest rate cut over coming months and the cancellation of a growing list of AUD30 billion plus mining/resources projects in Australia in recent weeks, the outlook for the AUD has to be more negative than continuing gains above $1.0550. Media reports that Fortescue Mining are “in discussions” with their bankers provides an indication of how rapidly profitability and cashflow have deteriorated in the Aussie mining/resources sector.
There was nothing in last week’s RBNZ Monetary Policy Statement to influence the NZ dollar upwards or downwards.
Despite the calls from some politicians and some business groups for the RBNZ or Government to “do something about” the higher NZD exchange rate value, the reality is that the current exchange rate above 0.8000 is due to USD weakness, not NZD strength.
However, forecast increases in NZ short-term interest rates are now much further away, particularly if the NZD/USD rate remains above 0.8000 for a prolonged period.
Following earlier quantitative easing announcements in the US (QE1 and QE2) the USD currency weakened a little further from the pre-announcement selling, however within a few weeks the USD was strengthening again as stronger US economic data came through. The same pattern is likely to repeat over coming months.
Therefore, both USD and AUD movements suggest a Kiwi dollar back below 0.8000 from here, rather than appreciation to 0.8500 or 0.9000 as many others are now forecasting.
The probability of the NZD/AUD cross-rate increasing to the 0.8200/0.8300 region has increased with the vulnerability of the AUD discussed above and the fact that two-year interest rate differential has reduced to 0.25% (Australian interest rates just above New Zealand’s).
On any AUD pullback against the USD, the NZD/USD rate is unlikely to fall as far as the AUD/USD rate, pushing the NZD/ASUD cross-rate upwards.
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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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