By Roger J Kerr
The comeback trail of the US dollar on global FX markets has run into a temporary snag as incoming Federal Reserve head-honcho Janet Yellen decides that continuation of more candy is what the US economy and hyped up equity markets need right now.
That Yellen leans to the dovish side when it comes to extending monetary stimulus is what the markets were expecting, however shifting the US unemployment rate goalposts from 6.5% to a lower 6.00% before commencing the unwind of QE is not what the markets were expecting.
The USD was sold against all currencies as a consequence.
The overall value of the US dollar on the USD Index has recoiled to 80.80 from being above 81.00 earlier last week. As a result of the weaker USD and higher Dow Jones Index, the Kiwi dollar has once again bounced of 0.8200 and trades higher to 0.8370.
The return to the EUR/USD exchange rate up to $1.3500 was not expected following the ECB cut in interest rates two weeks ago.
Weaker than expected US manufacturing and industrial production numbers released on Friday also weighed on the USD value.
The forex markets have now re-calibrated pricing of the USD to build in a March start to QE tapering.
My view remains unchanged in that the EUR/USD rate will be trading below $1.3000 by the end of the year.
Therefore the latest Kiwi gains do not look sustainable and a return to 0.8100/0.8200 is more likely than rates above 0.8400 again.
For the meantime it seems the global investors, hedge funds and traders have temporarily forgotten about markets risks such as emerging market economies and the monetary stimulus candy having to be ultimately removed.
Markets remain awash with excessive liquidity and fear has for the meantime dissipated in the world of risk assets.
It is inevitable that the US will taper back their monetary stimulus, particularly if the improvement in jobs continues at the rate it has been achieving in recent months.
At some point over the next two to three months global financial and investment markets will be forced to recognise that monetary policy in the US will be changing and this will throw sand in the markets’ well-lubricated complacency.
For these very good reasons the US dollar will be strengthening ahead in time of the wider financial/investment markets recognising that the candy store has run out of candy.
NZ dollar gains to 0.8900 against the Australian dollar over this past week also appear over-cooked and prone to reversal.
To be fair, NZ economic data has strongly out-performed Australian data of late and thus the forward pricing of the two currencies’ short-term interest rates has seen the NZ differential above Australia increase, and this always lifts the NZD/AUD cross-rate.
However from where I sit, the current very strong optimism and confidence in the NZ economy may be getting a little over-hyped, particularly if Wholemilk Powder prices start to correct back from their lofty heights i.e. it might be as good as it is going to get.
My gut tells me that the FX markets will take profits on the recent NZD gains against the AUD and send the cr0ss-rate back to 0.8700.
Australian economic figures have plenty of room to improve, ours do not as we are already running full to capacity in many areas.
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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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