By Roger J Kerr
Two weeks ago the Kiwi dollar was plummeting from above 0.8000 against the USD to lows of 0.7700 as the FX markets reacted to the unprecedented monetary policy initiative be way of a Reserve Bank of New Zealand media release, followed closely by the disclosure of official information on RBNZ intervention selling of the currency in mid-August.
There was at that time an expectation by many that the Kiwi dollar would continue down the abyss to 0.7500 and below.
This column was of a different view that the NZD/USD exchange rate would consolidate in the 0.7700/0.7800 area as all the sellers who wanted to exit the NZ dollar had largely already done so i.e. the NZD selling was nearly exhausted. (Also see our video interview with Roger here where he discusses bonds, interest rates, monetary policy and currencies)
For a variety of reasons the Kiwi has consolidated and stabilised and does not appear to be prone to further aggressive selling.
One reason for the NZ currency finding some legs of support was the fact that the US dollar itself has made spectacular gains against all major currencies over the preceding few weeks and was overdue for a correction and consolidation phase. The US Currency Index shot up in a straight line from 80.00 to 86.00 through September as the Europeans and Japanese contemplated further monetary stimulus and the forex markets started to price-in anticipated US interest rate increase in mid-2015. As has been stated many times in the past, the foreign exchange markets have a strong tendency to price today the next 12 months potential economic and financial market changes. The US dollar gains were hardly surprising.
Adding to the expected correction to the US dollar gains last week was some musings from the US Federal Reserve Governors that a strengthening US dollar currency value would make US manufacturing exporters uncompetitive and that was not good for the US economy.
A familiar story for manufacturers the world over, however not everyone can have a weakening currency as by their nature exchange rates are relative prices.
The risk of a stronger US dollar upsetting the US economic recovery is a long bow to draw as unlike New Zealand where imports/exports are 70% of the economy, in the US imports/exports only makes up 10% of the economy.
Exchange rate movements are just not that material to overall US economic performance.
The exchange rate comment by the Federal Reserve should prove to be a minor, throw-away line that is certainly not a significant monetary policy signal.
Further US dollar gains against the Euro and Japanese Yen have to be expected over the next 12 months after a period of consolidating-in the gains to date. The interest rate differentials in favour of the USD over the EUR and JPY just point to continued USD buying by global investors.
The renewed strength of the US dollar on the world stage is also heavily influencing commodity prices lower as these two prices react inversely to each other. Commodity end users such as Japan and Euroland need the USD commodity prices to decrease as their currencies weaken, to ensure stable raw material input costs in the home currency. These business drivers determine that commodities traded and priced in US dollars always decline in periods of US dollar strength.
New Zealand’s major export commodity, wholemilk powder (WMP), will again be the centre of attention this week as the markets wait to see if there is any signs of the free-fall in WMP prices at the Fonterra Global Dairy Trade auction coming to an end.
One would have to believe that WMP prices at now USD2,400/MT that protein buying food companies would be enticed to re-enter the market to secure the much lower price available.
Any stabilisation in WMP prices at current levels would be supportive of the NZD/USD exchange rate around 0.7700/0.7800.
The NZD/AUD cross-rate has returned to 0.9000 as the Australian dollar remains on a weaker trend with lower metal and mining prices. Revisions down in global economic growth forecasts over the next 12 months and weaker construction numbers coming out of China are weighing on metal/mining prices, thus the AUD’s value.
The Reserve Bank of Australian repeated their message last week that they prefer a weaker exchange rate to aid the adjustment from resources to other sectors of the Australian economy.
With no changes priced for Australian interest rates over the next 12 months, the NZ/Australian interest rate differential should remain constant and maintain the NZD/USD cross rate around 0.9000 for some time yet.
Sharemarkets in the US are finally reacting to the prospect of zero per cent interest rates coming to an end next year as well as a weaker tone to global growth. Sharemarkets heading south and risk being taken off the table by global investors is negative for the Kiwi dollar.
Combining all the contributing variables for the NZ dollar direction together suggests limited upside for the Kiwi dollar, however a free-fall to the low 0.7000’s is also unlikely with NZ interest rates still 4.00% above most other currencies.
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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