Roger J Kerr says when there is a decisive break to the downside below 84 USc it will trigger a whole series of stop-loss NZD sell orders as carry-trade investors exit

 By Roger J Kerr

Most gamblers, if not all gamblers, have a limit on the maximum tolerable loss.

It has the same with currency speculators.

Foreign exchange markets are open and trading 24 hours around the clock therefore hedgers and speculators alike use stop-loss and stop-profit orders placed with banks to automatically cut out of a loss position or take profits when the spot rate reaches the order level.

The offshore currency speculators and investors have been aggressive buyers of the NZ dollar over recent months, attracted by our 4.00% interest rate yield returns in a world of near 0% interest rates.

The “carry-trade” investors into Kiwi dollars are essentially currency speculators seeking both a running yield return if the NZD/USD remains stable and an enhanced return if the NZ dollar appreciates against the USD.

The attractiveness of the NZD carry-trade received a boost in early June when the RBNZ delivered a more hawkish than expected monetary policy statement (worried about strong immigration inflows, house prices and inflation threats).

The odds for the gamblers improved immeasurably as the Kiwi dollar become a one-way bet, with a 4.00% return carry to boot.

The NZD appreciated through June from 0.8500 to 0.8800 as a result.

Benign financial and investment market conditions elsewhere, with volatility at record lows, have added to the Kiwi’s attraction at this time

Just where these investors into Kiwi dollars have their break-even or maximum loss exit points is now the major issue in the FX market in respect to future NZ dollar direction.

If the majority of the carry-trade investors entered the Kiwi dollar from 0.8500 up to 0.8800, their break-even rates (no loss/no gain), after the 4% interest return is taken into account, are between 0.8150 and 0.8450.

We have already seen major support for the NZD/USD exchange rate at the 0.8450 level it sits at right now.

There is no question that a decisive break to the downside below 0.8400 will start to trigger a whole series of stop-loss NZD sell orders as the carry-trade investors exit.

As has been seen many times before in the NZ dollar forex market, offshore players who come into our currency underestimate the relative small size of the market and the lack of liquidity when they all rush the exit door at once.

The end result is rapid NZD depreciation as the sellers scramble and the buyers in volume become scarce.

My view is that the Kiwi dollar is on the brink of triggering massive stop-loss sell orders; it just needs a nudge below 0.8400 to start the process.

The expected movement from 0.8400 to 0.8100 could be somewhat rapid as a result.

Outside the collapse of milk powder prices, there is a lack of meaningful local and US data being released this week to cause that movement, so I am looking to events and sentiment in the AUD/USD FX market to drive change in the NZD/USD rate.

The RBA have seemingly now realised that the Aussie economy is not generating the replacement jobs for the reductions in the mine construction area.

They have revised down both GDP growth and inflation forecasts.

The Australian sharemarket was thumped again late last week and it appears global portfolio investors into Australian equities and AUD carry-trade currency players who are only getting a 2.5% yield pick-up have lost confidence and are both selling out.

A lower AUD/USD rate from 0.9275 stands as the short-term catalyst to cause a cascade of NZD selling as the stop-loss orders in the market are hit.  

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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