By Roger J Kerr
The Kiwi dollar has continued its consolidation phase against the US dollar between 0.7800 and 0.8000 over the last two weeks.
While testing both ends of the new trading range, the market does not seem prepared at this time to aggressively buy or sell the currency outside the newly established band.
The inevitable consolidation of the US dollar’s advances against all currencies on the world stage allowed the Kiwi to trade up to 0.8000, however tellingly there was no further buying of any conviction and plenty of sellers at the higher level.
The US dollar currency Index has settled between 85.00 and 86.00 with the EUR/USD exchange rate in the middle of its new trading band at $1.2700.
Interestingly, the foreign exchange markets have been much calmer and have not reacted in the same volatile fashion as bond and equity markets have recently to geo-political risks and events.
The FX markets have been expecting US interest rates to start to increase in 2015 and have bought USD’s in anticipating of that positive USD factor.
However, the USD buying has been measured to date as lower than expected inflation outcomes the world over are continuing to postpone the timing of those inevitable interest rate increases. For this reason it is difficult to see the US dollar racing away and forcing the NZD/USD rate to depreciate immediately to the low 0.7000’s.
In the short-run, the forex markets will be focused on this week’s RBNZ OCR review on Thursday 30 October and the US Federal Reserve’s FOMC meeting on the same day.
While the Fed Reserve will formally end the QE bond buying programme this month, their words on the future guidance of interest rates and the economy will be closely scrutinised as always.
The timing of both NZ and US interest rate increases in 2015 has been pushed back by the recent low actual inflation data and the current reductions in oil and commodity prices.
The RBNZ, and all other local economic forecasters, have been consistently forecasting inflation above actual outcomes over the past 12 months; however that does not necessarily mean that future inflation risks have totally disappeared. The domestic money markets are pricing one year swap interest rates at 3.78% and two year rates at 3.92% which is virtually saying that the OCR at 3.50% will increase less than 0.50% over the next three years.
The interest rate market has almost priced-out any future increases in inflation above its current 1% annual rate.
Arguably the market has become far too complacent about future inflation based on the current lower than expected actual inflation.
The inflation forecasting models might be in need of some repair and re-calibration; however inflation is far from dead in the NZ economy. A shortage of resources in the stretched construction sector and rising capacity utilisation in the manufacturing sector are just two examples of future inflation risks.
It is highly instructive to the future direction of the NZ dollar that the reaction to the benign inflation and interest rate outlook was only a very brief sell-off in the NZD/USD to 0.7800 and it has quickly retuned to 0.7900.
Looking ahead from current interest rate market pricing, the greater risk has to be interest rates increasing sooner and further than the benign 0.50% factored in over the next three years. The interest rate situation still stands as a Kiwi dollar supportive variable in 2015.
Nevertheless, RBNZ Governor Wheeler will be delivering a dovish commentary this Thursday. It is hardly a negative for your exchange rate when inflation is 1% and GDP growth is 3% and thus real wealth and income is being created.
Other potential positive factors for the NZ economy over the next 12 months that will mean the NZ dollar performs at a higher level than other currencies against a generally strengthening US dollar include recovering Wholemilk Powder fairy prices and progress on the Trans-Pacific Partnership trade deal. The NZ dollar cross-rates against the Euro, Japanese Yen and UK Pound seem set to track higher under these scenarios.
The NZD/AUD cross-rate appears set to remain in the 0.8800 to 0.9100 band for a prolonged period well into 2015 as neither NZ or Australian interest rates are expected to change, leaving the interest rate gap static at 1.20% (two-year swap rates).
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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