By Roger J Kerr
The NZD/USD exchange rate has finally pulled back from near record post-float highs.
The Kiwi has weakened over the last week from highs of 0.8830 to 0.8680.
It is arguably too early to conclude that the sentiment and direction has fundamentally changed, however the signs are gathering that the propensity for the carry-trade buyers of the high-flying Kiwi to buy even more NZ dollars is starting to wane.
For the Kiwi dollar to reverse out of its long-running uptrend a number of stars had to align and we are edging closer to that confluence:
1) Our major export commodity price, wholemilk powder (WMP) had to be decreasing, not increasing.
2) The US dollar itself had to be appreciating in global foreign exchange markets.
3) The RBNZ had to signal a pause to the increases in NZ short-term interest rates.
The current situation with these three pre-conditions for NZ dollar selling are as follows:
- Since February WMP prices have plummeted 38% from USD5,000/MT to USD3,088/MT at the last Fonterra/GDT on-line auction. The FX markets have been very slow to recognise this negative impact for the NZ economy, probably because the insatiable “chase for yield” which the Kiwi dollar is offering has for the short-term outweighed the weakening economic fundamentals.
- After months of sideways movement, the US dollar is finally gaining some traction due to increased global geo-political tensions in the Middle East and the Ukraine, continuing stronger US economic data that will inevitably force the Federal Reserve to change its rhetoric on monetary policy signals and renewed European determination to weaken the Euro.
- The third star is not yet aligned as the RBNZ is seemingly pre-committed to another 0.25% OCR interest rate increase on Thursday 24th July. The financial markets are expecting the fourth interest rate increase since March; therefore the focus will be on the accompanying statement from Governor Graeme Wheeler. The RBNZ are under pressure to protect their credibility by delivering something more tangible on their threats that they will intervene to push the NZ dollar down from its over-valued level. They have the delicate task of increasing interest rates, however contemporaneously talking the Kiwi dollar down with an accompanying message that they will pause for quite some time on further interest rate increases as the economic outlook is not as strong as they originally contemplated.
If the RBNZ was really serious about intervening to depreciate the NZ dollar they would surprise the markets by cancelling the 0.25% OCR increase on the 24th.
They are not likely to do that as the RBNZ does not dramatically alter its economic view over a short six week period from the last statement.
Therefore, the pressure will be on to clearly articulate in this review statement that export income is weaker than expected, mortgage lending rates have increased since early June and the housing market is showing further signs of levelling off after earlier buoyancy.
If Governor Wheeler gets the words right he will get away with a 0.25% OCR increase without pushing the NZ dollar higher on the day.
The RBNZ could also mention that actual inflation to date is showing no signs of uncontrollable increases and wage increases in the economy remain at generally low levels.
Stronger GDP growth above the sustainable non-inflationary growth rate is a good reason for tightening monetary policy to control future inflationary pressures and risks.
However, over recent months the previous rosy New Zealand economic picture has wilted somewhat with the high dollar and plunge in WMP prices.
Future inflation risks have reduced as GDP growth over the next 12 months is now likely to be nearer 2.5% than the previous 4%.
Removing the unique Christchurch rebuild from the equation has the 'rock star' economy suffering from smaller audiences and declining fan interest.
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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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