By Roger J Kerr
The price action in the NZD/USD foreign exchange market has tested both ends of the newly established 0.7200 to 0.7600 trading range over recent weeks.
The improvement in dairy prices and still continuing positive economic data saw the Kiwi dollar appreciate up to 0.7600 two weeks ago.
However, there was a ton of NZD selling interest at that level, the technical signals indicating a major resistance point at the 50-day moving average of 0.7600.
The retreat back from 0.7600 was equally swift as the US dollar put in another burst of strength on global currency markets and the local players decided to short-sell the Kiwi ahead of the RBNZ Monetary Policy Statement on Thursday 12 March.
Adding to the rapid Kiwi dollar pullback from 0.7600 to below 0.7300 was the scare/hoax on 1080 poison being added to our baby formula dairy products.
Any threat, including eco-terrorism, to our largest industry automatically has an impact on perceptions of our economy and currency as foreign buyers banning the containers of our food products flowing across their borders is disastrous for New Zealand.
Thankfully, the Government and the dairy industry were well prepared for any fallout and the event risk has quickly blown over.
The velocity of the wind and rain hitting New Zealand’s coastline from cyclone Pam will also affect economic developments over coming months.
The arrival of the rain will hopefully break the summer drought for east coast farmers and the risk or threat of lower agricultural production and thus weaker overall GDP growth appears to have reduced.
The test of the bottom end of the trading range ended at 0.7185 on 11 March, the day before the RBNZ prognosis on the economy. The FX markets had concluded beforehand that the monetary policy statement would be dovish (i.e. weaker economy with lower inflation and interest rate forecasts) and therefore many traders/speculators went into the statement holding short-sold NZD positions.
One or two economists from offshore banks who commentate on the NZ economy were calling for RBNZ interest rate cuts last week. Unfortunately, these currency gurus are not all that close to what is actually going on in our economy.
The economy is buzzing along rather well in 2015 with retail, property, construction, manufacturing and services sectors all enjoying robust trading conditions.
The Reserve Bank of New Zealand cannot hide from a strongly performing economy and for that reason their statement was never going to be as dovish as some of the deflation doomsayers were hoping it would be. The view that the New Zealand economy would automatically import Europe’s deflation and thus also cut interest rates was as misplaced as it was naïve. It was therefore no great surprise that the Kiwi dollar bounced off the lows reached before the RBNZ statement and the short-sold fraternity were forced to buy back their NZD positions. The Kiwi dollar recoiled to a high of 0.7425 on 12 March after the statement.
The US dollar remains heavily in demand globally as the markets price-in the giant chasm between monetary policy settings/direction in Euroland and the US. The Euro has weakened to below $1.0500 against the USD over recent days and has arguably over-shot an assumed fair equilibrium value around $1.1000.
A consequence of the strong US dollar against all currencies is that commodity prices (including oil), which move inverse to the USD, have fallen further away. Lower commodity prices are negative news for the AUD with iron ore, coal and copper prices reducing to new lows. The AUD/USD exchange rate has decreased to 0.7600 with the lower commodity prices.
The Reserve Bank of Australia had earlier identified 0.7500 as a more desirable value for the AUD and therefore may be less inclined to reduce Australian interest rates further from current levels. Provided the US dollar stabilises at current levels the depreciation of the AUD may be coming to an end. At 0.9600 the NZD/AUD cross-rate still appears to be too high relative to interest rate differentials between the two currencies that point to 0.9200 being a fair value. It will require a recovery in the AUD against the USD without the Kiwi moving to drive the NZD/AUD cross-rate down from 0.9600. The opportunity for this anticipated adjustment to occur will not be over this coming week with our GDP growth data for the December 2014 quarter likely to be +1.00% and thus NZ dollar supportive.
The central view that the NZD/USD exchange rate will remain in the 0.7200 to 0.7600 band over coming months remains much higher in the probability stakes than movements higher or lower.
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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