By Roger J Kerr
US monetary and fiscal policy decisions / events have been the dominant influences over the value and direction of the US dollar on international forex markets over recent weeks.
In a period when it was expected that the US currency would be strengthening due to their monetary stimulus starting to be removed and the massive reduction in the US internal budget deficit as a result of stronger tax inflows, in fact the opposite has occurred with the USD falling away against most currencies.
The US Dollar Index has declined to 80.25 from being comfortable above 82.00 only a few short weeks ago.
The recent negative forces against the US dollar in global foreign exchange markets are not likely to continue as the Federal Reserve’s decision not to commence the tapering of bond buying (unwinding monetary stimulus) is really only a postponement of the inevitable, not an outright cancellation.
The now almost annual political brinkmanship game in the US over their deficit and debt ceiling approvals should be resolved before the 16 October deadline.
Therefore, the US dollar should recover its lost ground as the drivers of the latest weakness are only timing issues, not fundamental game changes caused by sharply weaker economic data.
As always, both monetary and fiscal conditions in the US will be dependent on the economic data that is continually being released for the markets to absorb and react to.
The next key signpost for the FX markets will be the monthly US employment statistics (Non-Farm Payrolls) being released on Friday 4 October.
Federal Reserve chief, Ben Bernanke appeared more preoccupied with higher mortgage interest rates and Government fiscal tightening crimping the US economic recovery than jobs growth at his latest meeting update.
However, the critical determinant of when US monetary stimulus will be unwound is still the level of unemployment.
An increase of 180,000 jobs is forecast for the month of September, an outcome well above this figure will be positive for the USD currency value. Given that most of the lead economic indicators in the US are pointing to reasonably robust employment increases as retail, manufacturing and services industries all lift their activity levels; it remains very likely that the current 7.3% unemployment rate will steadily fall to 6.50% before mid 2014.
The US Federal Reserve had earlier signaled that this 6.50% unemployment target would determine the timing of the end of the Quantitative Easing (QE) programme. None of the recent monetary and fiscal events appear to have slowed the underlying pace of recovery in the US economy, so the latest USD weakness should only prove to be temporary.
The EUR/USD exchange rate has not moved too far from the $1.3500 level through these recent events in the US, with the ECB stating categorically that they see their interest rates remaining low for a very long time yet.
While there may be some debate as to the pace and evenness of the US economic recovery, there is very little dispute around the current and future strength of the New Zealand economy.
Excluding the 5% reduction in agricultural production (due to the summer drought) in the June quarter, the rest of the economy expanded at a very healthy clip.
Lead indicators for GDP growth here such as the Terms of Trade Index, which is back to record high levels again, point to the economy expanding by more than 4.00% over the next 12 months.
It is difficult to see the NZ dollar weakening too much in an environment where our relative economic performance is so superior to other countries.
Some arguments for the case that the NZ economy will not achieve its potential growth over the next year would be that Wholesale Milk Powder prices can only fall back from current record highs as global food buyers substitute cheaper inputs and the LVR speed limits on the banks cause a pull-back in the rampant housing market.
The spike higher in the NZD/USD exchange rate to 0.8420 on the US Federal Reserve “no tapering” surprise last week does appear is if it will be temporary and short-lived. There has been no follow-through buying by currency traders and speculators, with most now seeking to sell Kiwi dollars to take profits.
The AUD/USD rate has recoiled two cents from 0.9500 to 0.9300 since the burst higher on the Fed’s surprise.
The Kiwi dollar has yet to catch up with the latest AUD decline.
Global commodity prices have somewhat surprisingly weakened over recent weeks despite generally better than expected Chinese economic data.
The recent NZD/USD divergence from the CRB Commodities Index which it is highly correlated to is unlikely to last.
For these reasons a NZD/USD rate back to 0.8000/0.8100 in the short-term has a higher probability than further gains above 0.8300.
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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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