By Roger J Kerr
After failing to break above the ceiling area of its established trading range at 0.8100 following several attempts over recent weeks, the Kiwi dollar has retreated to the bottom end of the range at 0.7700.
The NZD/USD has been caught in some of the backwash from global foreign exchange markets as investors dump the emerging market currencies of Brazil, India, Indonesia, Turkey, South Africa and Mexico.
All these currencies have depreciated sharply against the USD as capital flows reverse due to the upcoming unwinding of US monetary stimulus.
Investment funds rushed into emerging markets when the US Fed embarked on their monetary stimulus after the GFC, now we are seeing the flows reverse as the US remove the candy from the markets.
While not categorised as an emerging market currencies, the NZ dollar and Australian dollar have also suffered selling pressure as investors lift their risk aversion generally.
The USD has also recovered somewhat against the Euro, moving from $1.3400 to $1.3200 as US economic data continues to outpace signs of some recovery in Europe (well, only Germany really).
The NZD has bounced back up from 0.7700 on at least five occasions over the last six months; there is now another severe test of that buying support.
Local economic data continues to support a stronger currency value with retail sales, consumer confidence, business confidence, a strong residential property market and agricultural commodity prices sustaining their record high levels.
All the data points to increasing interest rates in New Zealand in early 2014 as the RBNZ will no longer be able to justify loose monetary conditions with an economy expanding between 3% and 4% and the inflation risks that come with that.
A lower NZD/USD rate in the mid 0.7000’s does provide the opportunity to lift interest rates without hurting the export sector too much.
However, in the very short-term two international events will dominate NZD/USD direction, namely the Australian general election outcome on Saturday 7 September and the US non-farm payrolls employment numbers for August being released on the same day.
The mere uncertainty of elections normally causes currencies to weaken in the run-up to the voting day.
The AUD/USD rate is back at its lows at 0.8900 ahead of the polling date; however the general consensus is that a change of government in Australia will be positive for the AUD.
The large mining companies have apparently been holding off from new investment/expansion this year until they know the mining tax is gone for certain after the election outcome. The appreciating AUD after the election should also pull the NZD up against the USD.
Potentially countering that positive will be a stronger USD on the global stage if the US jobs figures are above prior forecasts of a 165,000 increase for the month.
Most of the lead-indicators for US jobs growth are pointing to stronger monthly increases and this is likely to see the Federal Reserve confirming the tapering of bond purchases starting this month. It is difficult to see that change not being positive for the USD currency value.
A stronger US dollar in global forex markets over coming months may well hold the Kiwi closer to 0.7600.
However, any push lower should be short-lived as international investors recognise the very positive economic consequences of high milk powder prices and a lower NZD/USD exchange rate. The NZ dollar looks set to outperform most other currencies in the face of a stronger US dollar environment. The result will be higher NZD cross-rates against the Yen, Euro and Pound. The USD is also gaining support from the geo-political ructions in the Middle-East with Syria.
The NZD/AUD cross-rate has not appreciated to above 0.9000 as many currency commentators were confidently predicting a few short weeks ago.
After touching 0.8900, the Kiwi has underperformed a stabilising AUD, causing the cross-rate to pull back to below 0.8700.
Basically, the interest rate markets on both sides of the Tasman have now fully priced-in expected NZ interest rate increases and Australian decreases over the next 12 months.
New Zealand two-year swap rates are now 0.75% above equivalent interest rates in Australia and this differential is now unlikely to change much over coming months.
The interest rate differential determines NZD/AUD cross-rate movements and therefore we can expect a stable NZD/AUD rate in the 0.8600 to 0.8800 range for some time to come.
In addition to the election result aiding the AUD, better Chinese economic data in the second half of the year will underpin hard commodity prices that Australia relies on.
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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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