Is the RBNZ brave enough?

Currencies

Roger J Kerr says the economy cannot sustain a major drought and persistent currency over-valuation and calls on the RBNZ to intervene

15th Apr 13, 8:41am by Roger J Kerr

By Roger J Kerr

The spiralling value of the NZ dollar exchange rate has hit the headlines yet again as a double whammy impact of international money flows into New Zealand and positive domestic development combine to propel the currency higher.

The NZD/USD exchange rate hit new 18 month highs of US86.75 cents on Thursday evening 11 April, however has since recoiled to US85.80c.

On the last occasion in August 2011 when the NZ dollar climbed to highs of US88c, it proved to be a very short-term spike and it quickly reversed to the low US80s.

There is no reason to believe that the pattern this time will be any different with the forces that have driven the exchange rate up not appearing to be permanent capital inflows, and thus more speculative in nature.

The overall Trade Weighted Index (TWI) reached a peak of 79.70 last week as all the cross-rates moved up. Again for what appears to be short-term reasons, the USD itself has weakened against the Euro and Australian dollar which has in turn caused these cross-rates to the NZD to lift with the NZD going higher against the USD.

The TWI has appreciated 6% up in a straight line over the last two weeks from 75.00 to above 79.00.

Global factors

The global factors include funds flowing out of Japan as the Yen weakens dramatically on FX markets and those funds seek out a stable currency with a reasonable interest rate return.

The NZ dollar fits the bill nicely.

The USD has lost ground on the back of two weak US economic numbers in March, their PMI manufacturing index was down and jobs figures disappointed after six months of strong gains in new jobs.

The USD declining to above $1.3000 against the Euro, however the outlook for the US and European economies could not be more diametrically opposed, so it is difficult to see the USD weakening any further.

Commodity prices have reduced over recent weeks and the USD currency normally moves in the opposite direction to general commodity prices, thus a USD recovery looks likely over coming weeks and months.

Local factors

The local factors that have added to the latest burst of NZD strength have largely been self-inflicted. RBNZ Deputy Governor, Grant Spencer highlighting the risks in the residential property market overheating earlier last week only fuelled NZD buying as the financial markets quickly concluded that RBNZ concern would only mean NZ interest rates being increased sooner than generally expected.

The Government Debt Management Office then issued $2 billion of new seven year bonds in one jumbo tender that naturally attracted strong foreign investor buying interest.

The Asian sovereign wealth funds who are keen buyers of the 3% yielding bonds have to buy the NZD’s to buy the bonds and they do not hedge back the other way.

Other local positives were higher business confidence (although the dominant agricultural industry suffering from drought is not in the survey) and still rising Wholemilk Powder prices. Our Prime Minister being in China and telling these massive global investors what a great economy we have probably added to offshore buying of NZ bonds and shares over this past week.

The recent combination of positive offshore and local forces on the NZ dollar has caused the TWI to increase a further 6% since the RBNZ Governor stated the currency was over-valued at a 75.00 TWI only a month ago.

Brave enough?

These events raise the real possibility of the RBNZ being forced to intervene directly in the FX markets to bring the value of the NZD down as all the pre-conditions and prerequisites for intervention have been fulfilled.

Whether the RBNZ is brave enough to push the button on interventionist NZ selling and thus take on global currency speculators is another matter.

The last time they directly intervened in the markets was in mid 2007 when the TWI spiked to 75.00. They made money on that occasion as the NZD subsequently depreciated. There is no guarantee they will make money again by selling the Kiwi at a 79.00 TWI, however the odds would certainly favour that they would.

Criteria

There are four criteria or tests that have to be met before they can intervene under the Reserve Bank Act and rules of engagement:

· The NZ dollar has to be at cyclical extremes of over-valuation (“exceptionally high level”) – No argument on that score as the TWI is 6% higher than the level the Governor described as over-valued only a month ago.

· The NZD/USD market movements and pricing has to be bordering on disorderly or dysfunctional to justify intervention to stabilise matters – Tick on that test as the TWI has gapped higher.

· Intervention must be consistent with the RBNZ Policy Targets Agreement – Tick.

· The currency intervention would have a reasonable chance of being effective and successful – a more subjective test as you do not know until you try! The RBNZ have to pick the opportune time to surprise the FX markets and cause speculative long NZD positions to be stopped-out and the NZD selling they started snowballs on itself. The RBNZ will be most nervous about the short-term timing and they should be holding off until the NZD starts to correct down and then time their selling to add to that reversing momentum.

It's justified

The intervention decision is a big call for the RBNZ; however the recent events justify the action.

They should seek the help from a few mates to add to the NZD selling, not just the RBA however the NZ Super Fund and ACC could take this opportunity to reduce their NZD hedging levels by a few billion as it appears the risk they hedged against (NZD appreciation) has already happened.

The New Zealand economy cannot sustain a major drought and persistent currency over-valuation.

Something has to give and eventually to FX markets will recognise that our future economic performance will be weaker this year than what most expect and thus send the NZD lower.

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Roger J Kerr is a partner at PwC. 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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16 Comments

by Hevi Groswaite | 15th Apr 13, 10:35am 1365978931

A lower New Zealand dollar will atract foreigners to our property market. I know of Californians looking to buy property in New Zealand, but holding back due to the high NZD/USD.

Back at the turn if the century, sounds so long ago, with our dollar at 39 cents, property yielded up to 35% YoY, including profits on the exchange back to USD just before the GFC. Very attractive investment, almost risk free!

Be carefull with what's wished for...

HGW

by am_fek | 15th Apr 13, 12:05pm 1365984344

This is a terrible idea. The RBNZ does not have nearly enough foreign exchange reserves to credibly influence the exchange rate, and in the world of central banking, credibility is everything. As Bill English put it (roughly), the RBNZ would be bringing a pea-shooter to a gun fight, and it would lose badly. That was also before Mr Kuroda in Japan decided to unleash his tsunami of QE a few weeks ago. Now it's a case of a pea-shooter versus a tidal wave. Hardly wise.

The author recognises the problem, that even after selling all of its NZD assets, the RBNZ still wouldn't be able to make a significant dent in the rate. Solution? Drag in the NZ super fund! I know all of you savers out there will be thrilled at the prospect of the super fund selling down all of its NZD assets as well. The result? In his other piece today the author predicts NZDUSD in the low 0.70s. Why is that a good result? Why because then we could set about hiking interest rates of course! Ah, the real agenda comes out again.

Just to get this absolutely straight, here is the plan:

1. Empty the RBNZ vaults of all NZD assets, even though it is acknowledged that this won't be nearly enough;

2. Empty NZ super of its NZD assets as well;

3. Ignoring the fact that Japanese QE totally changes the game and instead assuming that the above steps have a chance in hell of working, and that NZDUSD accordingly falls to around 0.70-0.75, immediately raise interest rates;

4. Watch as the carry trade pours in with a vengeance to buy the dip in NZD and to cash in on higher interest rate expectations;

5. Scratch heads wondering what to do as NZDUSD rises back up to 0.85 in double time, only now NZ super has been raided, the RBNZ has spent all of its NZD ammo, and the foreign speculators they set out to target have profited marvellously from the significant and very transitory buying opportunity we created by pawning off our national savings.

by Stephen Hulme | 15th Apr 13, 12:11pm 1365984674

The intervention decision is a big call for the RBNZ; however the recent events justify the action.

One should be told how big the RBNZ's losses are on the outstanding legacy ~NZD 1.8 billion short, yet to be covered, before we encumber further institutions funded by citizen's taxes.

We need to hold to account those who are responsible, so others are more diligent, or did I mean less negligent in future forays into foreign exchange trading on our behalf for the 'greater good'.

by Stephen L | 15th Apr 13, 1:48pm 1365990506

Stephen,

The one area of note that I sometimes disagree with you on.

I will take your word for it that the RBNZ has paper losses- booked or not- on past trading; but in my view they should look at the effect on New Zealand's wider interests in any case, and quantify the total effects.

There will be elasticities for supply and demand based on the exchange rate, (I'm not sure anyone knows what the reasonable levels are, but the RBNZ will have models) and they will impact on importers, import substituters, and exporters in various ways.

A very high exchange rate clearly favours overseas suppliers, such that our employment and our corporate profits would be less than they would be with a lower valued exchange rate.

So for the very narrow view of the RBNZ, we may lose from intervention; from the government funding position we should win (from lower welfare, and higher taxes), and from an overall point of view, measured by the current account, we should definitely win.

The key seems to me to be bold enough, and I'm not sure in the past we have been. If the RBNZ (with government support) is determined enough, it can bring the dollar down. Making the odd $100 million toe in the water will not be the answer.

Despite what another poster above you says, we don't need any foreign reserves at all to do it; in fact we would be increasing them.

by Stephen Hulme | 15th Apr 13, 2:22pm 1365992548

The authorities certainly can bring the NZD/USD currency pair down in value, if they so wished:

Victoria University Economist Geoff Bertram has proposed the Reserve Bank force New Zealand's banks to reduce their foreign currency borrowings to reduce the pressure on New Zealand's dollar and its export sector.

Bertram delivered a paper detailing the recent history of New Zealand's monetary policy, foreign borrowing and the New Zealand dollar to a Fabians' Seminar "Fresh Ideas for a Productive Economy" in Wellington last week. A full version of the paper is here.

In it he argues that New Zealand's inflation-targeting regime, its free floating exchange rate, unregulated capital flows and a sharp increase in foreign currency borrowing by New Zealand's banks since 1993 have had the effect pushing up the currency.

This has helped the Reserve Bank use the currency to suppress tradeables inflation and offset relatively high non-tradeables inflation. Read article

A local academic is not on his own voicing concerns about the woes of foreign wholesale borrowing undertaken by our banks.

Just last week, a note by Gareth Vaughan hightighted the concerns voiced by the credit rating companies:

Moody's downgraded the credit ratings of New Zealand's big four banks by one notch to Aa3 from Aa2 in 2011. Yu noted that a key factor in the downgrades was dependence on wholesale funding. Moody's estimates the big four, on average, source 37% of their funding from wholesale - both short-term and long-term - sources, with this including money sourced from their Australian parents.

In all our research we continue to highlight that the New Zealand banks' level of wholesale funding is a key constraint on the rating," said Yu. "They (the banks) have improved their position (since 2011), but even with this improvement, the banks' levels of wholesale funding is still a key concern."

In January Moody's highlighted that, at more than 140%, the New Zealand banking sector has the highest loan-to-deposit ratio out of 13 Asia-Pacific countries. Of the big four banks, S&P figures as of December 31, put ANZ's at 135.9%, ASB's at 136.6%, BNZ's at 162%, and Westpac's at 147.4%. Kiwibank's was 109.9%

by Stephen Hulme | 15th Apr 13, 2:27pm 1365992876

Last week, Christov kindly reminded me of my own contribution to this debate 10 years ago.

by Christov | 15th Apr 13, 2:37pm 1365993463

And well worth the read in retrospect to where we find ourselves I might add......

Someone that bothered themselves to ..do...something without pecuniary motivation for the benifit of the greater good.

by Stephen L | 15th Apr 13, 2:51pm 1365994289

Stephen,

Thanks, assuming you agree with Bertram, as I do, then you and I are on the same page.

The whole subject goes to David's 1 and 3 in the top ten today; as well as the possible solutions for the RBNZ to both a housing bubble and a high currency that Roger Kerr refers to.

David's 1 talks of the world moving to more national (as opposed to global) financing (where someone suggests that is a bad thing, without any reasons why); and also 3, the latest on currency wars.

The probably unwritten parts of Bertram's solution to me is that if the Banks here are forced/leant on by the RBNZ to seek higher local funding with some controls on capital coming in, are that:

The OCR would need to stay at least as high as it is now to attract that funding, so keeping housing under control. So, a good thing, and better for savers as it happens.

There may not be enough funds in play, which would be deflationary, without some extra local printing.

Both very achievable- just needs the political will and some kahunas somewhere.

by am_fek | 15th Apr 13, 3:36pm 1365996967

Obviously the RBNZ doesn't need foreign reserves to pull off the specific manoeuvre of selling short the NZD. However, for the market to take that move seriously and to be deterred from simply bidding it straight back up, credibility is definitely needed and foreign reserves are a significant element of central bank credibility. We are talking about hitching the NZ dollar to the Mickey Mouse bandwagon of manipulated currencies like the greenback and the yen. The only problem is that the BoJ and the Federal Reserve are able to maintain order and send effective signals to the market because they have the credibility that the RBNZ lacks.

You can't fight the market without credibility. It doesn't matter whether you are selling foreign denominated or local currency assets. Even if we are talking about a one-off intervention only, then speculators will simply buy the dips unless the RBNZ can show it has the guns to keep the NZD down. It doesn't. The new Japanese money has to go somewhere and the RBNZ simply won't be able to compete. Of course we could just print endless local currency but if we do that then one day we'll need those foreign reserves in order to prop up the kiwi. We also don't suffer from the same liquidity trap that Japan and the US do, so local QE would certainly let loose the inflation monster that OCR hawks on this site are so concerned about.

by am_fek | 15th Apr 13, 6:53pm 1366008806

Crossed wires here I think. What I meant was that RBNZ doesn't need foreign currency assets in order to short NZD, only NZD assets. Otherwise, I totally agree, it would be futile for them to try to fight the market - especially given the events of the past few weeks.

by Stephen Hulme | 15th Apr 13, 7:05pm 1366009541

Crossed wires here I think. What I meant was that RBNZ doesn't need foreign currency assets in order to short NZD, only NZD assets.

Exactly - out of thin air RBNZ printed NZD, in fact.

by goNZ | 15th Apr 13, 5:08pm 1366002503

nup

by taxPayer | 15th Apr 13, 7:45pm 1366011935

Possibly relevant in some way to all of these discussions - have a read of this one on Zerohedge - spot the outlier.

http://www.zerohedge.com/news/2013-04-14/which-nations-are-next-credit-…

Why are they seeing it and not us?

Cheers (I think) TP

by Allan Barber | 16th Apr 13, 8:45am 1366058738

Roger

You are wrong - the case for intervention only meets three of the criteria. The fourth one that it should be achievable is completely unrealistic and the Reserve Bank Governor knows it. Last time the Bank tried to intervene it cost money and was absolutely useless, like a peashooter against an elephant! this time would be no different.

Allan Barber

by raf | 16th Apr 13, 10:32am 1366065155

Some interesting comments on this thread. I have some thoughts to add:

The RBNZ can intervene in serious amounts, if it so wished. It does not need any reserves to sell NZ$, as it simply creates as many as it needs to. It could sell $50b if it felt like it. It could go as big as to sell an amount equivalent to our current overseas debt obligations (unhedged). Make no mistake, the RBNZ can get the currency down a long way if it wants to.

One problem with intervention, as noted above, is what happens when a certain level is hit, say $0.70 (or similar level in TWI). Imported inflation may cause interest rates to rise, thus encouraging new buying of NZ$ at vastly cheaper rates. Perhaps.

However, there are two other points worth considering:

1) The market would have been absolutely smashed and some overseas investors would be nursing serious losses. When this happens, new investors are reluctant to get involved and old investors tend to want to get out.

2) Once an appropriate level had been reached (for me this is a rate which would generate a $10-15b annual current account surplus), we can then institute capital controls, letting the currency trade in a reasonable band (5-10% either side of the fix). The prupose of this would be to embark on a repayment of our international debts, looking to wipe out our accumulated current account deficit, reduce specualtion in the currency, keeping it focused on international trade and real capital flows (this was the original plan at Bretton Woods).

This is all quite doable but requires a firm commitment to putting NZ interests ahead of overseas ones.

by raf | 16th Apr 13, 12:30pm 1366072201

As strange as it sounds, the Greens are actually the most proactive party in terms of policy development, even in the finance space. National are stuck in last century's orthodoxy (though Treasury is much more open to new thinking) and Labour are missing in action.