Roger J Kerr says a frustrated RBNZ will delay OCR hikes while the NZD is this high

 By Roger J Kerr

Foreign exchange markets often move in weird, mysterious and totally illogical ways.

In the end it always comes down to the time frames in which the movements are being considered and interpreted.

Taking the US dollar as an example, over recent weeks all the US economic news has been positive for the US dollar prompting the financial markets to expect that Federal Reserve tapering of bond buying may start earlier than what was expected through September and October.

In addition, there is apparent progress with the political committee in the US in reaching solutions for their budget/fiscal deficit.

All these factors would normally suggest gains for the US dollar against all currencies.

Perversely, for the meantime the FX markets have marked the US dollar lower against the Euro and Pound and the overall USD Currency Index has declined to 80.25.

While it does not make much sense that the USD has weakened, the rationale explanation is that short-term capital flows into the Euro from USD sources has driven the EUR/USD rate to above $1.3700 again.

Other short-term factors that have weighed against the US dollar include:

- European banks and multinational companies continue to sell off their offshore assets to shore up their domestic balance sheets and the repatriation of the sales proceeds into Euro’s has driven the currency value temporarily upwards.

- The Federal Reserve has convinced the markets that the commencement of tapering (reduction of money-printing stimulus) does not mean that US interest rates will be increasing anytime soon. The focus now comes onto the Fed’s FOMC meeting on 17 and 18 December in this respect.

- The FX markets themselves have been long US dollars in their speculative positioning in anticipating of the stronger US data (e.g. employment growth) and the failure of the USD to make gains after the economic releases has lead to USD selling to close the long positions down.

While the USD has not behaved as expected through November and December, the negatives are all short-term and thus not long lasting factors.

In the medium term, the out-performance of the US economy over Europe and the realisation that the US is reducing monetary stimulus whereas Europe is still increasing stimulus both add to a stronger USD currency environment in 2014.

The NZD/USD rate has bounced off the 0.8150 area on several occasions over recent weeks as the USD itself has lost ground in global FX markets. Rising wholemilk powder prices, record high terms of trade indices and record high business confidence levels have all been the very positive local forces supporting the Kiwi dollar.

However, the return to the higher 0.8280 level does not appear sustainable for a number of reasons:

- The NZD/AUD cross-rate has “straight-lined” higher from below 0.8700 to 0.9100 over recent weeks. FX market positioning in favour of NZD’s over AUD’s has been fuelled by the positive NZ economic data and not so positive Australian data. However, the interest rate differentials between New Zealand and Australia still point to a 0.8800 cross-rate, not 0.9100. Ahead of the Christmas holiday period and year-end expect to see considerable profit-taking in the form of speculative NZD/AUD positions being closed down i.e. NZD selling.

- Australian equity fund managers will also be looking at their position from being in poorly performing NZ stocks such as Chorus, MRP and Meridian. Recent FX gains would have insulated some of the pain for them, however one could understand them aggressively selling out before year end as “regulatory risk” overhangs the telecommunications and energy sectors in New Zealand from an overseas investor’s perspective.

- The AUD still appears vulnerable to further bouts of selling as international investors re-weight exposures to Australia lower as luck has run out for the lucky country in the post-mining boom era. The RBA are also clearly orchestrating a lower AUD currency value.

The RBNZ will again be worried about the high TWI Index level of 77.80 when they release their Monetary Policy Statement this Thursday.

Their forward interest rate track or guidance would normally be increasing given the strength of the NZ economy; however the continued weakness in the US dollar (thus the NZD well above 0.8000) is very frustrating for Governor Wheeler and he will be delaying interest hikes in 2014 while the currency remains at the elevated levels.

Traditionally, the Kiwi dollar is more volatile and makes gains over the Christmas/New Year holiday period.

The market environment may be different this year with the USD likely to re-exert itself and the AUD remaining vulnerable to disinvestment.  

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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