Roger J Kerr says recoveries in Wholemilk Powder prices and the Aussie dollar are pivotal for the NZ currency

By Roger J Kerr

The day-to-day trading range for the NZD/USD has been knocked down a peg over recent weeks as the neighbouring AUD remains under pressure and the FX market regarded the RBNZ Monetary Policy Statement last week as being at the “dovish” end of expectations.

The Kiwi dollar appears to be comfortable enough in the lower 0.6250 to 0.6450 trading range without displaying any real sign of breaking sharply higher or lower.

The speculative selling that pummelled the NZ dollar down from 0.7500 to 0.6500 in May/June on the back of collapsing dairy prices does appear to have run out of steam. However, there have yet to be any positives of sufficient magnitude to push the Kiwi dollar upwards.

Whilst the RBNZ lowered their GDP growth forecasts for the NZ economy for 2016 and 2017 (reducing from 3.00% to 2.00%/2.50%) it was of no real surprise as the markets and other economic forecasters had already reduced their forward expectations on the dairy slowdown.

One Wellington-based economic forecasting group who saw the RBNZ forecast change as “jaw-dropping” clearly do not get out enough!

The RBNZ’s overall assessment of the economy was balanced and conditional, certainly not as pessimistic on the outlook as several private sector economic forecasters have been of late.

What was interesting in terms of the financial market and media reaction to the statement was the “doomsday” scenario of China imploding and El Nino weather patterns damaging agricultural production painted by the RBNZ was interpreted by some as the central outlook, whereas it was just the RBNZ making everyone aware of the potential risks.

The probability of that doomsday scenario occurring on the economy is seen by this observer as less than 10%. Therefore, companies with FX exposures would not be advised to base a hedging strategy on such an outlying scenario probability. It would also be foolhardy to base monetary policy decisions too much on a weather forecast!

The future direction of Wholemilk Powder (“WMP”) prices after the bounce upwards to US$2,100/MT from US$1,500/MT in the last two GDT auctions remains pivotal to both NZ economic performance and thus exchange rate direction over the next 12 months.

Whilst Fonterra have withdrawn WMP supply from the past two and also upcoming GDT auctions which has aided the price recovery, industry sources still see “patchy” international demand levels.

It is arguably still too early to see evidence of a US and European supplier’s response to the much lower prices. Lower WMP volumes being offered to the globally traded market will eventually be their response, particularly as grain feed costs start to increase in Europe. The local NZD dairy futures are already pricing WMP higher over coming months to US$2,500/MT; therefore this Wednesday morning’s GDT auction results should again see another healthy increase in WMP prices. At some point to NZD/USD currency market will start to react more positively to the more rapid than expected recovery in WMP prices i.e. a higher NZ dollar.

All international financial and investment markets will be focused on this Thursday’s (17^th) decision by the US Federal Reserve to lift their official interest rates for the first time in nine years, or not.

Certainly, US economic data continues to be stronger, justifying an increase in September. However, the markets continue to price it as a 50/50 call as many see the Federal Reserve delaying until October due to recent market turmoil over the Chinese economic slowdown.

A 0.25% increase this week would not surprise the FX markets and thus would be neutral for the US dollar, whereas a delay would be seen as US dollar negative (higher NZD). The USD has already weakened to $1.1330 against the Euro ahead of the Fed decision, but such Euro strength does not seem sustainable when the ECB is printing money.

The dominant and critical influence over NZD/USD exchange rate direction over coming months is again expected to be AUD/USD movements.

The NZD still follows the AUD the majority of the time. The AUD depreciated to a low of 0.6900 against the USD on 6 September; however it has staged something of a recovery since to 0.7080. Metal and mining commodity price movements determine the AUD direction and those prices are largely driven by expectations about future Chinese commodity buying demand. The metal and mining commodity prices have reduced substantially over the last 12 months, rendering many mines around the world uneconomic.

It would seem that the hard commodity prices will only go lower still if the Chinese economy completely melts down. The fiscal and monetary policy capacity of the Chinese authorities to stimulate demand/investment if they need to is massive, thus a Chinese economic meltdown seems highly unlikely.

Australian economic performance (outside the resources sector) continues to improve; therefore the AUD (like the Kiwi dollar) must be seen as having depreciated far enough.

Local exporters selling in US dollars should be increasing long-term hedging percentages at the 0.6300 cyclical lows and not placing too much store on various exchange rate forecasts of the Kiwi going substantially lower yet into the 0.5000’s. The downtrend from 0.8800 to 0.6300 over the last 12 months is as steep and dramatic as the Kiwi dollar collapse to 0.5000 at the time of the GFC in 2009. At that time forecasts of 0.4000 were touted and those that relied on such forecasts wished they had hedged at 0.5000 when the Kiwi subsequently appreciated to 0.8000.

The lessons of history should not be ignored!

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