By Roger J Kerr
The hoopla in the media over this last week that the NZ dollar/Australian dollar parity party was a forgone conclusion, suddenly went quiet when the NZD/AUD cross-rate retreated sharply from 0.9970 to 0.9800, instead of sailing through to NZ$1 = A$1.
Everyone in New Zealand, from the Prime Minister down, has been celebrating the success of the NZ economy over the Aussie economy as reflected in the exchange rate almost at parity.
The poopers of the parity party were the Reserve Bank of Australia, who once again did the opposite to financial market expectations and did not cut their official interest rates from their current 2.25% level.
The Aussie dollar recovered in the FX markets against the USD, the Kiwi dollar did not follow and the NZD/AUD cross pulled back to 0.9800.
The real question for those NZ companies with profits and asset values exposed to the NZD/AUD cross-rate is whether the gains to 0.9900 are sustainable in the medium to longer term. Many local manufacturing and food exporters to Australia have been insulated against the 24% depreciation of the Australian dollar from 0.8000 to 0.9900 against the NZD over the last 24 months through prudent currency hedging programmes.
That hedging is rapidly running out and unless the exporters can secure price increases for their products in the Aussie marketplace, profits, output, investment and jobs will all be adversely impacted.
It is still surprising to observe that a number of NZ public-listed companies with substantial subsidiary businesses in Australia do not have adequate FX hedging programmes/policies in place to protect the conversion rate of Australian dollar profits into consolidated NZD group profits.
Shareholders should not accept an explanation from a Chief Executive that profits were lower than anticipated due to A$ currency headwinds that nothing could be done about!
Clearly such companies do not have appropriate hedging policies in place, or worse still, the Board of Directors take the mandate to make the currency hedging calls, or fail to make them as the case may be.
Two key variables and lead-indicators for the NZD/ASUD cross-rate do not suggest that exchange rates above 0.9800 are sustainable over coming months and point to a return to the low 0.9000’s:
- The gap or differential between NZ and Australian two-year interest rates has been a very accurate and reliable lead indicator for the movement in the NZD/ASUD cross-rate for many years. When Australia raised their interest rates in 2010 and then reversed their monetary policy and cut them in 2013, the interest rate differential correctly led the NZD/AUD cross-rate reduction to 0.8000 and the subsequent reversal to above 0.9000. The Australian two-year interest rate market is already pricing in further RBA cuts, therefore over the next 12 months the two-year interest rate gap should remain at 1.50% (NZ above Australia). The 1.50% differential suggests a return of the NZD/AUD cross-rate to 0.9200 i.e. 0.9800 is a massive speculative over-shoot.
- If the exchange rate parity of NZ$1 = A$1 is justified and permanent, then New Zealand wages and salary levels would be closing-up to be equal to those of Australia. That is not happening with the 20% income gap remaining in place and no-one forecasting the income differential to close.
The divergence of monetary policy and key commodity prices between Australia and New Zealand caused the speculative flows and trades out of Aussie dollars into the Kiwi dollar over the last three months.
When the speculators realise that parity is not going to be achieved and the key drivers mentioned above point to 0.9200, then it is easy to see current long NZ$/short A$ positions being unwound.
The release of New Zealand’s CPI inflation rate on 20 April is likely to stimulate many calls for the RBNZ to cut interest rates with the annual inflation rate reducing to near zero.
While the RBNZ is highly unlikely to reduce interest rates, the newswire headlines should cause independent NZ dollar selling.
A lower NZD/USD rate to the bottom of its 0.7200 to 0.7600 trading range, unrelated to AUD/USD movements, should see the NZD/AUD cross-rate lower again to the 0.9600 region.
To subscribe to our daily Currency Rate Sheet email, enter your email address here.
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