By Roger J Kerr
The rebound upwards in the NZD/USD exchange rate after the sharp fall from 0.8600 to 0.7800 has proven to be very short-lived.
The Kiwi dollar traded as high as 0.8150 last week, however it could not sustain the gains and his since retreated into the 0.7700’s as global sharemarkets slid away in the face of the candy (quantitative easing of monetary policy) being eventually withdrawn from the markets by the US Federal Reserve.
The world currency markets are starting to mark the USD stronger against all currencies on the confirmation that the US Fed’s bond buying (printing of US dollars) will be tapered back towards the end of 2013.
Foreign exchange markets always price the future economic/market conditions well in advance and the stronger USD also reflects the inevitable increase in US short-term interest rates even though actual increase may still be 18 months away.
Against the more certain backdrop of a stronger USD against all currencies over the next 12 months it is timely to reconsider the position of the key drivers and lead-indicators for the NZD/USD exchange rate:
Australian dollar direction against the USD
The NZD follows the AUD against the USD 80% of the time and is the by far the most important variable that determines future NZD direction.
While there are now some forecasts of the AUD depreciating further to 0.8500 against the USD after its 12% spiral over recent weeks from $1.0500 to 0.9200, the more likely scenario is some consolidation in the mid 0.9000’s.
The Aussie moneymarkets are pricing in another 0.40% of interest rate cuts, however the recent depreciation of the currency may well mean the RBA holds off from any more interest rate cuts ahead of the general election in September.
Chinese economic data outcomes and mining/metal commodity prices remain the critical determinants of AUD direction from here.
USD Currency Index and EUR/USD exchange rate
The correlation between the NZD/USD rate and the USD Index remains strong at above 80%.
The recent drop in the NZD/USD rate to 0.7750 brings the Kiwi dollar back in line with an 82.00 USD Index.
The USD Index ended an eight-year depreciation from 95.00 to 74.00 in mid 2011 and is now two-years into a turnaround that should see the Index move towards 90.00 as US interest rates increase and the US Balance of Payments continues to improve. Another 10% gain in the USD Index over the next 12 months should in theory pull the NZD/USD rate down from 0.7750 to 0.7000.
However, 3% GDP growth, rising interest rates and high agricultural commodity prices all suggest the Kiwi will out-perform other major currencies against the USD and thus not depreciate that far. On interest rate differentials and relative economic performance the Euro should be closer to $1.2000 than its current $1.3200 level.
Several global investment banks are now forecasting the Euro to weaken to $1.1500 and lower over the next 12 months.
Global investor appetite and the Dow Jones Index
International fund managers are rapidly downsizing their investment asset allocations to emerging markets, the exit of their funds weakening currencies like the South African Rand in particular.
Whether these investors are re-thinking their appetites for the so-called growth/commodity currencies (NZD and AUD) remains to be seen.
While the equity market reaction to the tapering of QE has been sudden and severe over recent weeks resulting in a falling Dow Jones Index, the future outlook for US equities has to remain mildly positive with a stronger economy, lower energy costs (shale gas) and US industrial firms globally competitive once again.
Wholemilk powder prices and NZ terms of Trade Index
There is a widespread expectation that the current elevated WMP prices above USD4,500/MT will correct down to around USD4,000/MT.
However, the global supply/demand equation over coming years suggests stabilisation at USD4,000/MT which remains well above historical norms.
High WMP prices is good news for our overall Terms of Trade, good news for the economy and thus positive for the NZ dollar value. A high WMP price is the one variable that points to the NZ dollar out-performing other currencies against a stronger USD. Higher NZD cross-rates against the Euro, Pound, AUD, JPY and all other currencies seem very likely.
Interest rate differentials
More likely to be a positive for the Kiwi dollar when NZ short-term interest rates inevitably increase in 2014.
Global “Performance of Manufacturing” Indices
Recent decreases in the US ISM Index and the Chinese PMI Index are not expected to continue as no-one is forecasting the global economy to fall back into recession.
NZ house prices
The NZ exchange rate Trade Weighted Index rose well above house price changes in 2010 and 2011. The historical correlation is strong and the increase in house prices in 2012 and 2013 have brought the two variables back into line with each other.
A further 5% to 7.5% increase in house prices over the next 12 months points to a stable TWI around the 73.0 to 75.0 region.
Relative Government bond yields
Asian sovereign wealth funds pouring money into NZ Government bonds (unhedged) has been a major factor in the NZD strength since the GFC.
Long-term bond yields above 4% are still going to be attractive to these investors; however the inflows will slow down as returns diminish with increasing yields (lower bond prices) and a weaker currency environment.
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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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