By Roger J Kerr
The second rebound upwards in the NZD/USD exchange rate from lows of 0.7600 last week seemed to surprise a few, however there should not have been any surprise to the markets that the RBNZ would deliver a neutral Monetary Policy Statement last Thursday.
Clearly the FX market went into the RBNZ statement very short-sold NZ dollars anticipating a dovish outlook and expecting continuing Kiwi dollar weakness.
The expectation was never realistic as the RBNZ were never going to see New Zealand’s inflation rate remaining static at 1% per annum over coming years.
However, the local moneymarkets had convinced themselves that very low inflation was here to stay and the RBNZ would forecast this.
When the RBNZ rightly delivered a balanced assessment of the economy and inflation going forward, the deflation brigade was forced to buy back their Kiwi dollars, sending the currency sharply up to a high of 0.7859.
I cannot see NZ inflation being as benign in 2015 as most forecasters are now confidently predicting.
The correlation between capacity utilisation in the economy and inflation levels (which the current breakdown thereof has the RBNZ somewhat confused) still holds in my book.
Add in importer currency hedging running off by March/April, and the low inflation scenario starts to change. New Zealand interest rates at 3.5% rising to 4% continue to underpin the NZ dollar value in the face of the negatives of a stronger USD, weaker AUD and lower dairy commodity prices.
Reflecting back on yet another topsy-turvy year for the NZD/USD rate where it traded in a 12 cent range from 0.8800 to 0.7600, reminds us all that a relatively heavily traded currency in global terms for such a small economy is always going to be more volatile than other free-floating exchange rates.
Therefore, looking forward to the likely forecast direction in 2015 has to be centred on a at least 10 cent trading range from top to bottom.
Most forecasts would not contemplate such a wide trading range; however there is nothing to suggest that history does not repeat in this respect. A 10 cent trading range from 0.7200 to 0.8200 cannot be ruled out; however I would favour a tighter band between 0.7400 and 0.7900 as a forecast.
My reading of local/international economics, markets and investor sentiment as 2014 draws to a close is summarised as follows:
- In the very short-term the AUD is way oversold against the USD. Profit taking on large short-sold AUD markets positions should see a reversion to 0.8400 over the short-term i.e. the NZD/AUD cross-rate will not stay above 0.9400 for very long.
- Wholemilk powder prices have the capacity to recover to USD3,000/MT earlier than most believe.
- Global investor risk sentiment will turn more negative as economic and credit conditions deteriorate in Russia with potential bank and corporate loan difficulties.
- US economic data, fuelled by lower gasoline pump prices will force the Fed’s hand in early 2015 to signal interest rate increases in the third quarter. Hard to see US 10-year Treasury bond yields remaining at 2.08% under this scenario.
- The EUR/USD exchange rate has the potential to decrease to $1.1500 (i.e. stronger USD, weaker Euro), however not a lot further as all the good USD news becomes fully priced into currency markets.
Global sharemarkets will struggle to repeat their positive returns of recent years under a rising US interest rate environment.
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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