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Roger J Kerr says investors will soon get the idea that the once attractive yield return is not enough to outweigh the risk of currency depreciation

Currencies
Roger J Kerr says investors will soon get the idea that the once attractive yield return is not enough to outweigh the risk of currency depreciation

 By Roger J Kerr

The New Zealand specific economic and market variables that drive 50% of the NZ dollar currency direction are now both decidedly negative and fully known.

Tumbling export commodity prices (particularly dairy prices) and a prolonged pause in interest rate increases have pulled the once rampant Kiwi dollar back from 0.8800 to 0.8500 against the USD.

Further NZD depreciation against the USD to below the 0.8450 support line will require the other side of the NZD/USD currency pair, the US dollar itself to strengthen on global FX markets.

The signals and signs remain very good for future USD gains against all the major currencies, and thus gains against the NZD and AUD as well.

After two years of stability around 80.00 level, the USD currency index has finally gained some traction in recent weeks to 81.30.

Over the last month the USD has made significant gains against the Euro from $1.3900 to $1.3400. Further Euro weakness is anticipated to $1.3000 over coming weeks/months as the European monetary authorities (ECB) engineer additional monetary stimulus to address deflation threats and weak consumer spending.

The strength of the Euro over the first half of 2014 was seen as a major reason for Euroland inflation to decline to very low levels of 0.40% per annum.

The Europeans want a lower Euro currency value.

The NZD/USD exchange rate remains highly correlated to the EUR/USD rate and thus a continuation of the weaker Euro trend will pull the Kiwi dollar lower.

The forecast USD gains against the Euro are however more about US and international investment funds re-rating the USD currency higher and adjusting portfolio allocations to position for the first period of USD exchange rate strength in more than eight years.

Last week there were three key US economic announcements that all contributed to the building case for US interest rate increases and along with that a stronger US dollar currency value.

- The US economy expanded at a faster than expected rate in the June quarter, the +4.00% annualised GDP growth rate well above prior market forecasts of +3.00%.

- The Federal Reserve meeting revealed that whilst Chair Janet Yellen still has lingering concerns about the labour market utilisation levels, there is an increasing recognition of the momentum in the US economic recovery with inflation and wages increasing. Many market participants are now factoring in the first Fed interest rate increase in March/April 2015, brought forward from the previous June 2015 timing.

- The US jobs increase of 209,000 for the month of July was marginally less than forecast; however the average monthly increase for the last six months since February has been a very strong +245,000. The employment figures headline last Friday may have temporarily disappointed some US dollar bulls, however there is no denying the underlying strength in the US labour market with increased jobs in important manufacturing and business services sectors.

Over coming months the US economic evidence will continue to build on itself and support further appreciation of the US dollar.

Falling dairy prices and the tea-break from the RBNZ have reversed the NZ dollar direction and scared-off additional carry-trade buyers of Kiwi dollars.

It will be general USD strength from here that will now persuade existing holders of NZ dollars that the once attractive yield return is not enough to outweigh the risk of currency depreciation.

A break of 0.8450 to the downside should quickly result in NZD/USD rates in the 0.8200’s.

There are some difficult decisions coming up for local exporters in USD’s as to where to start the rebuilding of their currency hedge books. Longer-dated collar options (18 to 24 month terms) would be advised from the 0.8300 entry level staggered down.

From a spot entry rate of 0.8100 forward exchange contracts will again be the hedging method.

Exporters in Australian dollars have again seen the benefit of having NZD buy orders placed with banks at and below the 0.9100 level to build up their hedging percentages again. 

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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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1 Comments

It will be general USD strength from here that will now persuade existing holders of NZ dollars that the once attractive yield return is not enough to outweigh the risk of currency depreciation.

 

Why would the US commit to extinguish it's more than extraordinary liabilities held by foreigners with value - it hasn't since it dropped the gold standard back in 1971? What's changed?

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