Here's our monthly currencies outlook and review with HiFX's senior dealer Dan Bell including a look at the Reserve Bank's currency intervention and when the US Federal Reserve may look to remove its quantitative easing (QE), or money printing, punch bowel.
Data released by the Reserve Bank yesterday shows it sold NZ$256 million in April in a move that Bell said had actually proved quite effective in weakening the New Zealand dollar.
"On the big scheme of things NZ$256 million is not a lot and everyone was actually quite surprised to hear it was only that amount," Bell said. "To put things into perspective the daily spot volume in the New Zealand dollar-US dollar is about US$30 billion so NZ$256 million from the Reserve Bank in the month of April is really just a drop in the ocean."
However, Governor Graeme Wheeler was showing the market that he did intervene to try and weaken the New Zealand dollar, the first time the Reserve Bank has done so for five years, and, Bell suggested, he was also showing an ongoing willingness to use currency intervention to smooth out spikes in the Kiwi dollar.
"I think at the end of the day, whilst a lot of people looked at the amount they actually sold in April as very, very small and a bit of a joke really, he was quite effective because of his timing," Bell said. "And he actually intervened at a time when it was quite effective and clearly the New Zealand dollar dropped from around the US86 cents mark to close to US80 cents overnight, so in the space of a few weeks we've had quite a decent drop there."
And in a speech on Thursday Wheeler said the Reserve Bank is prepared to "scale up" its currency intervention if it sees opportunities to have a greater influence in the value of the Kiwi dollar. Bell said Wheeler appeared to be keeping his options open.
"At the end of the day he (Wheeler) can jawbone the market all he likes. But when it comes down to actually intervening he knows that it's very difficult for a small central bank like the Reserve Bank to intervene in the currency market. And ultimately he only wants to do so when it is effective so I think we have to give him credit for that," Bell said.
"At the end of the day I don't think anyone from a policy or a government point of view really likes the idea of (currency) intervention, but if we can smooth these rallies in the New Zealand dollar and get on to these times where the Kiwi is under a bit of pressure and push it a little bit lower, I think that's a good thing. Ultimately we know the challenges our economy faces from a currency point of view have got more to do with US monetary policy rather than New Zealand monetary policy, or the New Zealand economy. So we're just trying to push back on a situation which is pretty much outside of our control."
RBA rate review pending
On Tuesday the Reserve Bank of Australia will review Australia's cash rate, currently 2.75%, now only 25 basis points above New Zealand's 2.5% Official Cash Rate. Bell said no change is expected this time, after the 25 basis points cut in early May, but another cut was expected in the third quarter.
Developments in Australia are set to provide a challenge to New Zealand's Reserve Bank over coming months.
"Australia's our largest trading partner so what happens in the New Zealand dollar versus the Australian dollar is extremely important in terms of our competitiveness in that market. And obviously if the Australian economy's not doing as well, then New Zealand's not going to be doing as well. So I think that's going to be a big challenge over the next 12 months and perhaps isn't something that we're paying enough attention to," said Bell.
Goldman Sachs economists this week suggested the New Zealand dollar could reach A90c over the next 12 months and Bell agrees the Kiwi's likely to outperform the Aussie.
"I don't think it's going to happen overnight, but the underlying trend is there. There are some aspects in the New Zealand economy which are going to give us a little bit more momentum over the next 12 months compared with Australia where the resources and mining boom is starting to run out of puff," said Bell.
"The amount of money that has been pushed into that sector has peaked as at last year, and the prices being paid for a lot of Australia's commodities have come off a lot and look like they're going to continue to trend lower."
He noted that Citibank analysts recently called an end to the so-called commodity super cycle, which has benefited Australia hugely in recent years.
What will the Fed do?
Meanwhile Bell said the biggest game in the currency markets remained trying to figure out when the US Fed would slow, or end, its QE programme. The Fed is buying US$45 billion in long-term Treasury bonds and US$40 billion of mortgage-backed securities monthly, as it strives to boost the US economy by pushing down long-term interest rates to encourage borrowing, spending and hiring.
Data out during the week showed the first year-on-year double digit rise in US house prices since early 2006. Other recent news hasn't been so strong. Official figures show the US economy grew at an annualised rate of 2.4% in the first three months of the year, down from the 2.5% rate originally estimated for the quarter. And the US Labor Department said initial jobless claims for the week to May 25 rose 10,000 to a worse-than-expected 354,000.
However, Bell said the underlying trend in the US economy was positive with house prices a key driver. Traders and investors are therefore trying to pick how and when the US Fed may scale back, and/or end QE. With its overnight bank lending rate at between zero and a quarter percentage point since December 2008 the Fed's now into its fifth year of QE.
"The recent rhetoric coming out of the US from (Fed Chairman) Ben Bernanke and the other voting members at the Fed is that yes they are open to tapering off some of this quantitative easing that they've got on the table," said Bell.
"The Fed has been expanding its balance sheet by about US$1 trillion a year. At some stage they need to start to normalise that and everyone's concerned about the impact that's going to have on the US economy, and the global economy for that matter."
There was potential for a correction, or fall, in global stock markets if the Fed starts removing its stimulus. And the yields on US 10-year government bonds have gone from about 1.63% to over 2.1% in less than six weeks, in a "massive move", Bell points out.
"And if you compare the yield on the US 10-year note to Japan and Germany there is quite a big premium being built in there now as the market anticipates a stronger US economy and a normalisation in their (the Fed's) policy position."
"It's not going to happen overnight. But I do think they'll start to taper off the amount that they're purchasing - they're going to have to need to at some stage," said Bell.
He suggested this could happen before the end of the year with a reduction in the Fed's monthly bond buying by, say, half.
"They're testing the market at the moment I think, testing to see what impact it may have," Bell added.
"Taking the stimulus off the table is going to have a big impact on their economy if you think about it. The US$1 trillion they're printing is going to have to come from somewhere else."
"It wouldn't surprise me to see the New Zealand dollar push back up towards the US81.5c to US82c level in the next week or so. But overall I still think we've got more downside potential back towards those levels that I keep talking about around US75c by the end of the year," said Bell.
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Dan Bell is the Senior Dealer at HiFX, a UK-headquartered foreign exchange dealer with significant operations in Australia and New Zealand. It has a dealing room in Auckland. See more detail here.