Roger J Kerr doubts the 65 USc view of John Key will be reached, suggesting most manufacturers and exporters have moved on from seeking a 'cheap dollar' strategy

Roger J Kerr doubts the 65 USc view of John Key will be reached, suggesting most manufacturers and exporters have moved on from seeking a 'cheap dollar' strategy

By Roger J Kerr

Much has been made over this last week of Prime Minister John Key’s view that a fair equilibrium value for the NZD against the USD is 0.6500.

Being a former currency trader the PM’s personal prognosis on exchange rate direction naturally attracts plenty of air-time.

It is hard to know what the PM’s motivation is in predicting a much lower NZ dollar value from current levels of 0.7760.

If he believes that local manufacturers exporting their product in US dollars need a 0.6500 exchange rate to make a buck and keep/increase jobs he may be a little out of touch in my view.

My observation is that after four years of the Kiwi dollar trading largely above 0.8000 most manufacturers have adjusted their business models to be profitable at a 0.8000 exchange rate level.

They have adjusted input costs, selling prices and markets where they are able to maintain profitability. Proactive currency hedging has helped these companies as well.

It could well be that the PM’s much publicised Kiwi dollar view was merely an attempt to give Governor Wheeler at the RBNZ a helping hand to drive the Kiwi dollar down in value.

As both gentlemen will know too well, words will only go so far when it comes to currency markets.

At the end of the day it is the combined decisions of buyers and sellers that determine how far an exchange rate will move in a certain direction.

My interpretation of recent events with the Kiwi dollar and its future outlook is that a 0.6500 level over the next 12 months is quite a low probability of occurrence.

For another 16% depreciation to 0.6500 to occur on top of the 12% drop from 0.8800 over the last three months, the following stars would all need to align:

- Continuation of general USD strength in global forex markets with the EUR/USD rate falling another 16% from the current $1.2500 to $1.0500. Whilst there are a few minority currency forecasters picking the Euro to weaken to this extent, most would see a $1.1000 to $1.2500 trading range over the next 12 months. The NZD/USD and EUR/USD rates are reasonably correlated, however it is a brave man that bets the Kiwi dollar will be weaker than the Euro with our interest rates 4.00% above those in Euroland. Further USD gains against all currencies are expected, however arguably not enough to push the NZD/USD rate all the way to 0.6500.

- Wholemilk powder (WMP) prices would need to continue their nose-dive on top of the 50% collapse from USD5,000/MT to USD2,400/MT already recorded over the last six months. At some point very soon buyers must return to the WMP market as the negatives of the China inventory overhang and changes to EU regulations become fully priced-in. Cow cockies will be hoping so! Any stabilisation and mild recovery in the WMP price over coming months should be supportive of the Kiwi dollar in the mid 0.7000’s area.

- Something going horribly wrong in the NZ economy that forces the RBNZ to cut interest rates, rather than further increases in the OCR expected in 2015. It is very difficult to see what could go wrong with the wider economy (outside the dairy industry) looking pretty robust at this point. With very sticky non-tradable inflation and rising tradable inflation from the currency weakness it is impossible to see the RBNZ cutting rates, more likely is another 0.75% to 1.00% of OCR increases in 2015.

Picking the bottom of the Kiwi dollar’s fall is never easy.

The two critical factors to provide confidence that the bottom is forming will be a stabilisation of dairy prices and the US dollar reaction to the Federal Reserve signalling interest rate increases in 2015.

The next three months until Christmas should provide useful guidance on these two key factors. 

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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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12 Comments

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Being a former currency trader the PM’s personal prognosis on exchange rate direction naturally attracts plenty of air-time.
 
It is hard to know what the PM’s motivation is in predicting a much lower NZ dollar value from current levels of 0.7760.
 
It would be better for all concerned if Key could point to defensible conclusions such as these:
 
A 10% depreciation of the euro:

  • Increases euro-zone exports by 4.2% (given the increase in their relative price);
  • Increases euro-zone imports by 3.1% (given their relative price);
  • Therefore increases the euro zone’s level of GDP by only 0.2 percentage point. Read more

 
 

Stephen, The Euro zone does not seem a great example in that it is so distorted by Germany and the rest. In total, the euro zone has a current account surplus of 2.4%, (or ~$300 billion) with Germany having most of that with a 7.5% (~$250 billion) surplus on its own. They do need to lift consumption, but the Germans are resisting, and in fact want their fellow Europeans to stop consuming, while they don't increase theirs. A depreciation in their case is a two edged sword, as you say. If a current account in balance is the goldilocks rate, then they should expect a devaluation. On this I agree with Evans Pritchard of the Telegraph, that the Italians/French/Spanish etc should revert to their own currencies, but that is an aside.
Given NZ's CA deficit of ~$7-10 billion, the relative elasticities should be greater here.
Throw in some modest capital management tools, such as tighter foreign ownership criteria, or the RBNZ matching private inflows with public outlow purchases; or even direct RB funding of significant infrastructure investments, then the exchange rate would likely find an equilibrium at somewhere near Key's 65c. I note that he seems to be saying that is the ideal goldilocks rate, which is somewhat different to him predicting it.
The impact on GDP may also not be significant, I could grant, but the rebalancing within GDP to export/manufacturing/domestic tourism away from house and farm swapping should be significant if the RBNZ and government show some mettle.
 
 

Stephen L - I am not assuming that the Euro can used as a comparison ccy for NZD woes - I am hoping, against all odds, for similar analysis particular to the circumstances surrounding the NZD to be deployed and presented along with the PM's so far unsubstantiated claims that NZD/USD 0.6500 is an acceptable outcome.

Stephen,
Then if I understand you, we are in total agreement.
Matt Nolan mentioned before the election the idea of a transparent in depth inquiry or study into what was the best monetary policy for NZ, and I also agreed with him then. I have my expectations of the various elasticities on capital and current flows both ways, and on a rebalancing of the economy, with both a lower exchange rate, and of say the RBNZ having an extra current account target, along with some capital management tools as proposed by David Parker. (Winston Peters' policies would have ended up in the same place). But I'm more than happy to accept that my views are best guesses and could benefit from some significantly more robust analysis.
Whatever the analysis suggested, then the idea of leaving a fair bit of the heavy lifting with the RBNZ also appeals, as any government will start looking at elections 1-2 years out, and will make populist rather than ideal decisions from about then. The RBNZ can and should see past such cycles.

Stephen L, I have as much disdain for current central bank policy as this man does -
 
Jim Grant: We’re in an Era of ‘Central Bank Worship’  Read more
 
 

Conclusion – it is the root cause of dollar strength that is most important
While the S&P 500 may not be correlated to the dollar and translation may be dismissed as accounting, dollar strength is important, in our opinion, because it is a symptom of decelerating international economic growth. This is particularly true for Europe, which is the second largest market for S&P 500 companies. European growth has continued to slow and our 2014 GDP estimate is now just 0.7%. In addition, deflation remains a concern, with recent inflation readings of just 0.5% and long-term expectations falling below 2%. Outside of Europe, China has slowed, Japan is growing at just 1.1%, and Brazil is grappling with recession.
Read more
 
Not many expanding markets, no matter how low the NZDUSD ccy pair collapses and the actions and thoughts of the NZ authorities will matter little.

"My observation is that after four years of the Kiwi dollar trading largely above 0.8000 most manufacturers have adjusted their business models to be profitable at a 0.8000 exchange rate level."

Translation: the others have already gone broke and we don't want more startups.

Beat me to it...I was going to add 'have gone bust or moved overseas' to Roger's list.
Not many are profitable at 80c, most are just getting by in the hopr they become profitable.

Beat me to it...I was going to add 'have gone bust or moved overseas' to Roger's list.
Not many are profitable at 80c, most are just getting by in the hopr they become profitable.

The dollar is only a small part of the problem, its the cost structure to support the elites and the overpaid civil servants and council workers that is killing industry.

You are right in that there a lot of problems that are being covered up. A big concern for me is the lack of profit leads to less available cash for R&D in firms which is going to impact their future too.

The less available cash (or cheap debt - ie debt at cost of repayment risk, not from arbitrary interference and lender profiteering) also means less cash available to hire foreign or local expertise.     

Just look at the villages in a Banana Republic.  They don't have engineers to fix their problems, or reflectors and factories to work their abundant resources.  Because any income is sucked away rather than returned back into the system... their "currency supply" source sucks away their profits.
 The system then reaches a point of stagnation, of equilibrium.   "no new markets" for the wealthy to exploit is the most damning and revealing comment.   So what do such folks do? Do they develop new markets through thought and investment? No.  They iPhone 9 it, they rebrand.... they try to turn existing supporters into paying customers to line the bottom line.... this is the corpse consuming itself.

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