Roger J Kerr sees the NZD returning to trade in and around 0.8000 over the balance of the year

 By Roger J Kerr

The Kiwi rugby league players were almost gazumped in the weekend by a bad case of over-complacency, the same could be said about Kiwi dollar bulls who were proclaiming last week that the currency was a new international “reserve” and “safe-haven” currency and was likely to go higher from 0.8500.

RBNZ chief, Graeme Wheeler’s subtle and timely “jawboning” down of the Kiwi dollar last week has proven to be quite effective, the NZD/USD rapidly retreating from highs of 0.8500 to trade below 0.8300 by week’s end.

By indicating that the Kiwi dollar was over 5% higher than the level assumed in their latest official economic forecasts, the Governor was inferring that perhaps interest rate increases in 2014 could be delayed as inflation would track lower under a stronger exchange rate environment.

The resulant reduction in short-term swap interest rates (two and three years) was in stark contrast to rising Australian short term swap rates as a higher inflation outcome there persuaded more in the market that further RBA OCR cuts are unlikely.

The unexpected and diverging direction of interest rates on both side of the Tasman pulled the NZD/AUD cross-rate sharply down from above 0.8800 to rates below 0.8650.

Governor Wheeler has another opportunity to influence financial market sentiment this Thursday, 31 October with the OCR review.

US underlying fundamentals good

The Governor’s statement is likely to make the observation that the Kiwi dollar has been pushed up higher than expected at this time due to the monetary and fiscal uncertainties in the US during September and October.

There is a growing view in the currency markets that the Fed’s delay on withdrawing monetary stimulus to 2014 and the political/fiscal games in the US are short-term aberrations that do not change the underlying economic fundamentals that ultimately determine exchange rate values.

The US economic recovery maybe a little uneven and patchy, however it has a real forward momentum that comes from consumer/retail spending, improving real estate markets, increased industrial output and the shale gas revolution that has slashed energy costs to US manufacturers.

Resultant increases in jobs has also been uneven, however the lead indicators all suggest stronger jobs numbers over coming months. Add on the unheralded, yet spectacular decreases in the both US’s budget deficit and external balance of payments deficit and the prerequisites for a stronger US dollar are all in place.

Sentiment towards the US dollar in the global foreign exchange markets has turned negative of late as a result of the spill-over from the monetary and fiscal events of the last two months.

Those events are now in the past, and as FX markets are always forward-looking it has to be expected that the USD will recover lost ground against the major currencies. The Canadians have revised their outlook on interest rate increases and the Europeans will be thinking hard about their monetary policy settings when their horrible unemployment situation is reconfirmed this week.

Prospects for the NZD

While New Zealand has no control over the value of the USD in world currency markets, local exporters will be hoping that the international forex markets do start to recognise the strength of the US economy over and above Europe and mark the USD to a stronger level.

General USD strength on the global stage will be needed to keep the NZD/USD rate down as the New Zealand specific economic fundamentals all point to the New Zealand Inc share price (the exchange rate) rising, not falling.

The prospect of being the first in the world to lift interest rates after the GFC, record high wholemilk powder prices, rising house values, increasing inward migration and a 4% GDP growth rate in 2014 all suggest a stronger currency.

However, exchange rates are relative prices and where the NZD/USD rate travels over coming months will largely depend on what the USD itself does.

The Europeans will not be happy with a EUR/USD rate of $1.3800 and can be expected to do something about that by signalling the need to lower their interest rates further to get their economies recovering.

There will also be concern at recent AUD currency strength in Australia as metal and mining commodity prices have drifted lower over September and October. The net result is lower exporter incomes and it seems consumers have yet to start spending in Australia in response to much lower mortgage interest rates. While further interest rate cuts in Australia are not expected, both the new Government and the RBA would prefer the AUD to be closer to 0.9000 than 0.9500 against the USD.

The NZD/USD rate has again failed to push higher above the 0.8500 point against the USD, as it has also failed on four separate occasions over the last three years.

New buyers of the NZD, whether speculative traders or long-term investors, are not interested in entering the Kiwi dollar at such lofty heights.

The sharp reversal in the Kiwi dollar last week is again another sign that a fairer equilibrium value is closer to 0.8000.

Bringing all the strains that influence the NZD/USD rate together, the conclusion has to be that the Kiwi will again return to trade in and around 0.8000 over the balance of the year.

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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