Roger J Kerr sees the NZD at 78 USc in a few weeks as the lower dairy prices bite and the US dollar strengthens - and lower still if there is political uncertainty

 By Roger J Kerr

The NZD/USD exchange rate has taken a breather from its long-awaited depreciation from record highs over the past fortnight.

The Kiwi has traded between a low of 0.8310 and a high of 0.8420 as it goes through a period of minor consolidation after the rapid five cent drop from 0.8800 to 0.8300.

The momentum and sentiment still appears to be firmly downwards for the NZ dollar as various factors combine to produce more parties seeking to sell the Kiwi than there are buyers in the marketplace.

The rebound upwards last week from the low of 0.8310 was not too surprising as profit-taking on short-sold positions taken on above 0.8600 is always a variable in the ebb and flow of currency markets.

However, there has been no serious follow-through buying on the gains up to 0.8400.

Some Kiwi dollar buying was stimulated by Fonterra’s confirmation last week of their forecast $6/kg milksolids payout to dairy farmers. While Fonterra will have some 2014/2015 FX hedging in place around the 0.8200/0.8300 area, it will still require either material NZD depreciation well below 0.8000 and/or a recovery in Wholemilk Powder (WMP) prices to actually deliver a $6/kg payout.

Fonterra themselves seem to be hoping for some recovery in the global WMP prices, however other sources in the dairy industry still point to warehouses full of milkpowder in China which will overhang the market and not allow any price recovery.

The materiality of the 40% fall in dairy prices on the wider NZ economy is only slowly being realised by economic commentators, politicians and the agri-business sector.

At least the RBNZ belatedly saw the risk to the economy and flip-flopped from the stringent June monetary policy statement to the “pause” statement in late July.

At the end of the day lower WMP prices, lower dairy farmer incomes and thus lower GDP growth all point to a lower NZ dollar in its own right.

It was expected that the overall import/export price index, the Terms of Trade Index would fall by up to 5.00% in the June quarter. That has not happened with the Terms of Trade Index staying up at 40-year highs due to the high NZ dollar in the June quarter reducing import prices as much as WMP and other export commodity prices.

The fall in both the NZD and WMP prices since June suggests that the Terms of Trade Index is set for a major shift downwards in the next two quarters.

Consistent with the tone and predictions of previous columns, the US dollar itself continues to make gains against the major currencies of the world.

The Euro has weakened to $1.3130 against the USD due to deflation trends in Euroland and investor disinvestment as the Ukraine/Russian conflict intensifies. Further Euro selling to below $1.3000 is expected in the near term.

The Japanese Yen has not benefited from global geo-political tensions as it normally does. Poor economic performance and the widening future interest rate gap means investors favour the USD over the Yen.

The UK Pound Sterling has recoiled sharply from above $1.7200 to the USD to $1.6600 today as more recent UK economic data has not printed as strongly as previous trends. The timing of anticipated UK interest rate increases has been pushed further forward into 2015.

There is no reason to suggest that the USD strengthening trend should not continue over coming months, particularly if there is another strong US employment increase for the month of August this Friday.

The Australian dollar has been the one currency over recent weeks/months that has maintained its position against the USD, hovering above and below 0.9300. It will require weaker than expected Aussie economic data in the interest rate sensitive parts of their economy (housing and retail) to dislodge the RBA’s current stance of “no change” to their OCR interest rate levels. It is not expected that the AUD will buck the trend of other major currencies weakening against the resurgent USD, therefore from here AUD/USD decreases should match NZD/USD decreases and leave the NZD/AUD cross-rate in and around 0.9000.

It is hard to judge how much the closing-up of the political opinion polls against the ruling National Government will impact on the NZ dollar exchange rate.

The dirty politics revelations are appearing to shift some voters to the smaller parties such as NZ First and the Conservatives.

If there is a high level of uncertainty as to who might be able to form a Government after the 20 September election night, the NZ dollar will be sold as foreign portfolio investors and currency traders/speculators do not like political uncertainty that can lead to economic policy uncertainties/risks.

The NZD/USD rate has dropped five cents over the last six weeks.

It may take a few more weeks to drop another five cents to 0.7800, however all variables point to that occurring. 

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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