By Roger J Kerr
The stabilisation and consolidation of the NZD/USD exchange rate over recent weeks in the 0.7300/0.7400 area has defied the strong view of the Reserve Bank of New Zealand that the currency is unsustainably and unjustifiably higher than it should be.
The stability at these levels has also defied the majority of local bank forecasts that the Kiwi dollar would continue downwards to 0.7000 and below through this period.
There are several explanations for the Kiwi dollar’s defiance and the forex markets in pricing the rate at 0.7450 are reading these signals:
- The US dollar itself has eased off from its relentless appreciation against all currencies over the last six months. The USD Currency Index has levelled-off at 94/95 as the markets appear to have already fully priced increases in US short-term interest rates later in the year from the Federal Reserve. All the negative news coming out of Europe for the Euro’s value in terms of the massive QE monetary stimulus announced in January was built into the EUR/USD exchange rate in advance. The EUR/USD rate stability in the $1.1200 to $1.1400 range over recent weeks has allowed the Kiwi to also stabilise.
- For the meantime, NZ dollar selling has been exhausted with all the carry-trade investors and hedge fund speculators who were quick to exit the Kiwi dollar on the breaking of key support levels of 0.8000 and 0.7600 having now departed. Overseas investors are not yet racing back in as buyers; however those that wanted to get out of NZ dollars have done so.
- Wholemilk powder prices (WMP), our dominant commodity export, have rebounded with vengeance in recent weeks from USD2,400/MT to above USD2,800/MT. A classic short squeeze in the market and some panic buying by dairy product end-users as they assimilate the news of lower production from New Zealand due to dry climatic conditions.
- Whilst the Kiwi dollar has outperformed the Australian dollar (pushing the NZD/AUD cross-rate back to highs of 0.9600) over recent times, the overall linkage to the AUD/USD remains strong. It is instructive to the future direction of the AUD that it has not depreciated any further against the USD following the decision by the Reserve Bank of Australia to cut their OCR interest rates to 2.25%. Again that event was fully-priced into the AUD exchange rate in advance of the announcement. The Australian dollar has depreciated a long way over recent months on the back of lower commodity prices and lower interest rates. All the bad news for the Aussie economy and currency may now be known and fully priced into the exchange rate.
Looking ahead, there is no getting past the fact that the New Zealand economy is performing well above the level of others and the 3.50% to 4.00% interest rates available make us stand out as an attractive investment destination in a world of zero returns and considerable economic/event risk.
A global fund manager scanning the world for a reasonably safe and acceptable return at this time would be pushed to locate anything better than NZ bonds or equities as an asset class allocation.
Investment returns, like exchange rates, are relative financial outcomes and both Australian and New Zealand offerings stand out from the pack currently.
The NZ dollar has also benefited from a de-escalation of global event risks on the FX markets over recent days. Oil prices have stabilised and recovered somewhat and the now more likely outcome with Greece’s debt crisis is a compromised “muddle-through/kick the can down the road” result rather than a debt default or exit from the EU blow up.
However, there are still risks around for the Kiwi dollar, the most important being a continuation of the hot dry summer slashing agricultural production and GDP growth.
The overall Trade Weighted Index (TWI) value of the NZ dollar is back at a mid-point of 77, well down on its highs of 81, but above the 75 level forecast and desired by the RBNZ.
Another potential risk for the NZD/USD rate to the downside is unwinding of speculative NZD/AUD currency market positions from a cross-rate of 0.9600 which again looks to be an over-shoot. NZD selling against the AUD may see the NZD/USD remaining stable around 0.7400 when the AUD corrects back up to above 0.8000 against the USD. A lower NZD/AUD cross-rate to 0.9200 would be the result of this re-alignment of the two 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