Roger J Kerr sees the NZD/AUD moves all priced in; suggests exporters lock in the EUR cross rate now

 By Roger J Kerr

After a brief foray above 0.8000 last week, the NZD/USD exchange rate has rapidly returned to its now familiar trading range between 0.7700 and 0.8000.

Continuing weakness in the AUD against the USD to below 0.8900 over recent days has pulled the NZ dollar back sharply to 0.7830 and lower again to 0.7705 on the contaminated dairy product scare or “event risk” over the last 24 hours.

It is instructive for the future direction of the Kiwi dollar against the USD that the market did not push the Kiwi higher on its own accord following two very positive local economic news stories over recent times, a very strong business confidence index and Fonterra increasing its dairy farmer milk solids payout forecast to $7.50/kg.

Despite these two positive Kiwi dollar variables the decline in the NZD/USD rate to 0.7700 tells us that global and USD factors are weighing more heavily on the currency than local economic developments.

Reports of potential health issues in NZ exported dairy products would have been a negative influence on the NZ dollar as well.

Just how quickly Fonterra can move in the short-term to reverse bans on imported NZ dairy product into key export markets like China will determine whether there is short-term negative on the NZ dollar value or something more prolonged.

The standout highlight in the local foreign exchange markets over recent weeks has been the dramatic appreciation of the NZD /AUD cross-rate from 0.8600 to highs of 0.8900.

The Kiwi dollar has outperformed the AUD against the USD, pushing the NZD/AUD cross-rate higher for several very good reasons:-

· Australian short-term interest rates have been priced progressively lower as their moneymarkets anticipate more OCR cuts by the RBA, whereas the NZ moneymarkets have priced in a higher probability of an increasing OCR in 2014. The two-year swap interest rate differential has continued to point to a higher cross-rate and the resultant capital flows in favour of the Kiwi dollar have delivered that outcome.

· New Zealand’s soft/agriculture commodity prices have moved up, whereas Australia’s hard metal/mining commodity prices have generally decreased on softer than expected Chinese economic data.

· New Zealand’s domestic economic data has continued to be stronger with retail, housing, jobs and manufacturing all positive, in comparison the run-up to the general election in Australia has prompted Australian households to sit on their hands and thus domestic economic trends in Australia have been flat to poor. The blow out in the Australian Government’s budget deficit as tax revenues fall away is testament to the weakness in their economy. 

However, it can be strongly argued that all the positives for higher interest rates in New Zealand and all the negatives for lower interest rates in Australia have already been fully priced into forward interest rate markets, and therefore fully priced-in to the NZD/AUD cross-rate.

Trader profit taking looks likely to pull the NZD/AUD cross-rate back to 0.8700 from the current levels of 0.8800.

Several local currency forecasters are picking the NZD/AUD cross-rate to go above 0.9000 and higher, however this seems unlikely unless the bottom falls out metal/mining commodity prices that Australia relies upon.

Chinese economic data appears to be stabilising with the latest PMI manufacturing result remaining above the 50.0 level.

GDP growth in the US and Japan is looking much more healthy, therefore substantial further falls in hard commodity prices is unlikely from here.

The RBA OCR cut this week may well be sell the AUD on the rumour ahead of the announcement, however buy it on the fact, as the forward looking FX markets start to factor in eventual interest rate increases later in 2014 for Australia.

Remarkably, the Euro has managed to post gains against the USD to $1.3300 despite the medium term outlook being for US interest rate increases and European interest rate decreases.

The Euro strength appears very temporary indeed given the outlook for the two economies being so much in favour of the US.

Local New Zealand exporters in Euro’s should be taking the opportunity of the dip in the NZD/EUR cross-rate to 0.5850 to cement in long term hedging contracts.

Rising interest rates in New Zealand next year and lower interest rates in Euroland for longer point to this cross-rate shifting substantially higher to 0.6500 in the medium term.

A return to the USD strengthening against the Euro to below $1.3000 should pull the NZD/USD exchange rate lower to test the 0.7700 support area again over coming weeks.

The Kiwi’s big run up against the AUD on the cross-rate may have run its course; the next big gain on the crosses is likely to be against the Euro and UK Pound as those currencies weaken further against a stronger USD than what the Kiwi dollar does.

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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