By Roger J Kerr
The Reserve Bank of New Zealand is likely to be becoming increasingly frustrated at the foreign exchange market’s response to their monetary policy review statements.
Even though they repeated their consistent message that the NZ dollar is extremely over-valued at the OCR review last week, the forex market sent the Kiwi even higher following the statement.
The market clearly went into the statement short-sold the Kiwi dollar at the 0.8400 level, and when the statement was a mere middle of the road summation of the current RBNZ interest rate and foreign exchange dilemma, the short sold position takers were forced to buy back their Kiwi dollars.
Like the first spike higher to 0.8670 two weeks ago, this latest burst upwards for the currency appears temporary and short-lived.
Already a stronger USD generally on global FX markets has pulled the NZD/USD rate back below 0.8500.
What is apparent from the currency’s price action over recent months is that every pullback to lower levels is ending at a progressively higher exchange rate. A month ago the support line was just below 0.8200, now it appears to be in the 0.8300’s.
There is no immediate local event or economic development on the horizon that looks likely to break the Kiwi dollar out of its relentless trend higher.
Foreign capital inflows, attracted by our 3.00% interest rate yields which are higher than most others, have not abated and underpin the Kiwi dollar’s strong position for the meantime.
It is not disclosed or known whether the RBNZ were getting close to intervening directly in the NZ dollar currency market when the TWI Index hit 79 recently. The pre-conditions for intervening are arguably all fulfilled; however whether the RBNZ have the confidence to pull the trigger to push the currency lower is another matter.
Despite the current strong NZD performance, there are three major developments or forces that stand to be potentially significant medium term negatives for the NZ dollar going forward:
1. The USD itself is now appreciating against most major currencies after nine years of depreciation from 2003 until 2012. The USD Index has posted gains from 75 to 82 over the past 12 months and continuing improvement in US economic data will eventually lead to a majority of Governors on the Federal Reserve Board wanting to commence the withdrawal of the current massive monetary stimulus.
The inevitable cutting of interest rates in Europe over coming months looks set to send the Euro currency the same way as the Pound and Yen against the USD on global FX markets.
2. Foreign investor capital inflows into the NZ dollar to buy NZ Government Bonds must slow up when the currency and bond yields start heading in the opposite direction. To date the bond investors have enjoyed capital gains on the bonds as yields have moved lower and exchange gains on top as the Kiwi dollar has gone higher.
When the currency reverses and bond yields are increasing the investment returns will turn sharply negative.
Not all investors will pull their money out, however the inflows will disappear and remove one massive support for the Kiwi dollar.
3. Political risk for the Kiwi dollar is looming on the horizon following the announcement of the Labour/Green electricity policy. Foreign investors will be perturbed as the local business community as to the ramifications and precedents for Government interference and control of other parts of the economy.
New Zealand has held a reputation of political stability that keeps economic policies consistent and predictable, the policy shift to semi-nationalisation of the electricity sector is sufficient to scare the horses in the currency markets.
If the political opinion polls start to show some traction for Labour and the Greens following the seismic policy shift to the left, the NZ dollar may come under pressure reflecting the politically generated economic uncertainty and risk.
While these variables maybe some months away from coming fully onto the radar screens of the NZ dollar foreign exchange market, there do not appear to be any upcoming and off-setting positive factors to counteract the resultant Kiwi dollar selling.
The AUD/USD rate continues to grind lower in a zigzag pattern as weaker than expected Chinese GDP and manufacturing economic data pull hard commodity prices down.
The NZ dollar’s out-performance of the AUD against the USD has driven the NZD/AUD cross-rate to three-year highs of 0.8270.
The increases in our food/agriculture commodity prices against reductions in Australia’s metal and mining commodity prices justifies the NZD appreciation relative to the AUD.
However, the latest NZD/AUD cross-rate gains may have the Kiwi dollar too far ahead of itself as the recent spectacular increases in wholemilk powder prices do not look sustainable when the new dairy season commences in September.
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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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