By Roger J Kerr
The high value of the NZ dollar is again a focus of media attention following its further appreciation to above 0.8600.
The latest bout of strength coming from a string of positive local economic data releases (e.g. February’s whopping trade surplus), a stronger AUD against the USD and comments from the RBNZ post the first OCR increase earlier in March.
The AUD gains to 0.9250 against the USD are somewhat difficult to comprehend at a time when their key metal and mining export commodity markets have declined in the face of weaker Chinese economic data.
The FX markets have marked the AUD higher as they believe the Chinese central bank will now be forced to loosen their monetary conditions and that is positive for future infrastructure spending and thus rising steel / coal / copper prices in the medium term.
However, the last thing the Australian economy needs in this period of transition, post a mining boom, is the currency and resource prices to diverge. The current AUD strength above 0.9200 to the USD does not appear very sustainable.
Closer to home, business groups, the Minister of Finance and the Governor of the RBNZ have all been commenting that the NZD/USD exchange rate above 0.8600 is over-valued and will cause challenges for the economy.
The RBNZ sometimes do not help themselves as Deputy Governor, Grant Spencer in a speech delivered in Hong Kong last week indicated that the majority of USD exporters had adjusted their business models to the high NZ dollar value and interest rates may have to be shunted up more rapidly if inflation increases quicker than forecast.
The observations by Mr Spencer were accurate enough, although USD exporters would contend that they have adjusted to a 0.8000 exchange rate, not to a 0.8600 level.
However, the words chosen by the Deputy Governor on these matters could have been more carefully selected.
The Kiwi dollar was aggressively bought by speculators following the comments, which is not really what the RBNZ are trying to achieve.
The overall value of the NZ dollar, measured by the Trade Weighted Index (TWI) has appreciated to a post 1985-float high of 81.00 over recent days.
A review of the individual major cross-rates over recent years highlights the fact that the NZ dollar has now completed a paradigm shift higher against all six currency pairs:
- EUR and GBP cross-rates ramped up 20% in 2010 and 2011 as those currencies weakened on the European debt crisis.
- The JPY cross-rate jumped 37% from 65.00 to 89.00 over 2013/2014 when the Japanese commenced printing large dollops of Yen.
- The AUD cross-rate spiralling 19% higher from 0.8000 to 0.9500 from mid- 2013 as monetary policy management diverged in Australia and New Zealand.
- The CAD cross-rate increasing 20% from 0.8000 in early 2013 to 0.9600 as the Canadians changed their minds on their interest rate intentions in late 2013.
- The NZD/USD cross-rate being the final swift shift up from 0.8000 to 0.8650 on the back of strong domestic economic data, the OCR increase and a stronger AUD against the USD.
So, is there a case today for the RBNZ to intervene directly in the forex markets to push the NZ dollar value downwards from its over-valued position?
Under the RBNZ’s rules there are four criteria or prerequisites that must be fulfilled before direct intervention in the FX markets is contemplated:-
Commentary on whether the criteria is met
|The TWI value exceptionally and unjustifiably high in terms of economic fundaments?||What fundamentals? The high Terms of Trade supports a TWI at 81; however the Current A/c deficit does the opposite.|
|Consistent with PTA - 1% to 3% inflation?||Yes, a TWI back at 77 or 78 would not threaten the annual inflation rate moving up above 3%.|
|TWI at a cyclical extreme?||Yes, on any historical measure.|
|Reasonable chance of success?||Who knows? RBNZ need to catch the FX market at extreme long NZD positions to hit stop-loss orders going down.|
RBNZ Governor, Graeme Wheeler is widely reported as not being overly keen on currency intervention.
He has been frustrated by the fact that the USD itself has not strengthened on global FX markers at the same time he has had to increase NZ interest rates.
The RBNZ would argue that the high Terms of Trade currently supports the high exchange rate and should the export prices fall back the currency would follow.
Therefore, the first prerequisite for intervention is not met.
However, as the charts below show, the Terms of Trade Index is dominated by wholemilk powder prices and those prices are down 10% over recent weeks.
Intervention would seem unlikely and it would be more effective for the RBNZ to just not increase the OCR at the end of April, surprise the pundits and that would cause greater NZD selling and depreciation.
The RBNZ may come under pressure to do just that if the TWI stays up above 80.0 over the next four weeks.
Further falls in WMP prices at the next Fonterra/GDT auctions on Tuesday 1 April and Tuesday 15 April may do the RBNZ’s currency intervention job for them.
USD importers must be seriously lifting hedging percentages at current exchange rates above 0.8600.
Investors seeking to diversify into equities or other investments outside New Zealand will also be attracted by the high currency entry point as well.
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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