By Roger J Kerr
Over the last six months the movements in the NZD/USD exchange rate have once again re-confirmed the historical adage and trading pattern that the Kiwi dollar goes up the escalator in a stepped progressive fashion over time, however when it falls it is straight down the elevator shaft!
After consolidating in the 0.7600 to 0.7900 trading range through October, November and December, the Kiwi has broken out to the bottom side over recent weeks.
The global and domestic market forces that have driven the NZD/USD rate down from 0.7700 in late December to current lows of 0.7260 are summarised as follows:-
• Continued Euro weakness against the US dollar following the ECB delivering on a massive Quantitative Easing (“QE”) monetary package last week.Time will tell whether the money printing will help a recovery from deflation and no growth in Europe to improved economic performance. The EUR/USD rate decreasing from $1.2000 to $1.1200 over recent weeks.
• Further general strength in the US dollar itself against all currencies as positive economic data aided by lower gasoline pump prices keeps the Federal Reserve on track for interest rate increases in the US sometime in the third quarter this year.
• The currency markets selling the AUD and NZD aggressively following a surprise cut of interest rates by the Canadian central bank. The dramatic collapse of oil prices is decisively negative for the Canadian economy as oil/energy is a major industry and export. The FX markets just lumped the NZ dollar in with the CAD as a fellow commodity currency, however lower oil prices are positive for the NZ economy.
• The Reserve Bank of New Zealand delivering a more dovish than expected OCR review statement on Thursday 29 January and introducing the prospect of interest rate cuts in the future (subject to economic data). The current inflation rate is below the 1.00% minimum limit the RBNZ is mandated to control and they are now forecasting little change to this very low level of inflation right through 2015. The 0.2% decrease in inflation for the December 2014 quarter prompted NZ dollar selling when it was released on 21 January. The forex market has sold the NZ dollar down because the outlook for monetary policy has swung from interest rate increases in the second half of 2015 to the possibility (unlikely) of an interest rate cut.
The increased volatility of the NZ dollar of late is consistent with very uncertain and troubled global investment and financial markets at this time.
The markets are very unsure how this year will unfold with deflation in Japan/Europe, rising interest rates in the US that should hurt equity markets, emerging market economies damaged by low oil/commodity prices and slowing economic growth rates in China.
In respect to international foreign exchange markets the unanswered question is how much of the USD gains to date (17% increase in the USD Index from 80 to 94) have already priced-in the divergence in monetary policy settings between the US and Europe.
A stabilisation of the EUR/USD rate in the $1.1000 to $1.1500 range would leave the Kiwi dollar between 0.7200 and 0.7600. However, continued USD strength over coming months to a EUR/USD rate of $1.0000 would see the Kiwi some 10% lower as well, well below 0.7000. PwC’s view is that the USD will stabilise in the $1.1000 to $1.1500 area and leave the NZD/USD rate above 0.7000.
The second major determinant of future NZD/USD direction from current rates of 0.7260 will how the NZ economy performs this year, whether inflation starts to lift and whether the RBNZ will be forced to adjust their current “neutral” monetary stance as a consequence of under-estimating those inflation outcomes.
Stronger economic data over coming weeks (e.g. employment growth) will put pressure on the RBNZ’s newly dovish position and potentially push the Kiwi dollar upwards as the prospect of an OCR cut disappears entirely.
Local retailers are already hinting at substantial price increases over coming months, yet the RBNZ have strangely and suddenly dismissed the impact of a much lower NZD/USD exchange rate on imported consumer goods.
While the NZ dollar has seemingly been pole-axed to lower than expected levels over recent weeks, the 4% interest rates and superior economic performance relative to the rest of the world does not allow a continued free-fall in the NZD/USD rate in our opinion. In the low 0.7000’s the NZ dollar will be at a more attractive entry point for offshore hedge funds and currency investors.
For these reasons PwC recommends increasing USD export hedging percentages to secure the lower rates available.
Previous sharp dips in the NZD/USD rate over the last five years have all proven to be valuable hedging opportunities as the chart below displays.
PwC observes that from a pure risk management standpoint, with no regard to views as to where the NZD might be in 12 months’ time, adding to hedging percentages at current levels below 0.7300 is very prudent financial management.
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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