By Roger J Kerr
The Kiwi dollar has depreciated by five cents from the highs of 0.6880 on 30 December 2105 to a low of 0.6380 last Friday night. The reasons for the decrease have been many and varied, however it is has not been due to a stronger US dollar currency value on global foreign exchange markets as many have been expecting.
The US dollar has remained within a relatively tight $1.0600 to $1.1000 trading range against the Euro since the Federal Reserve raised their official interest rates on 17 December. The US dollar has recently weakened back to the top end of that range at $1.0920. The stronger Euro and weaker NZD against the USD has pulled the NZD/EUR cross-rate back to 0.5920.
Very uncertain and jittery world sharemarkets since the start of January has been the principal reason for the NZ dollar weakness. International investors and traders have commenced the year in a very defensive and :risk-off” mode as they react to heightened global geo-political tensions, massive falls in the oil price and weaker Chinese economic data.
However, the main reason for retreating sharemarket values in 2016 appears to be a long over-due correction to over-valued equity markets over recent years as a result of the economic/investment anomaly of zero or negative cost of money (interest rates).
The citing of a more abrupt economic slowdown in China as a reason to be more negative on the global economy appears very similar to what happened last August. Dire predictions for what a collapsing Chinese economy would mean for the rest of the world precipitated plunging share markets and a weaker NZ dollar at the time.
It was always the view of this column last August that the Chinese monetary and fiscal authorities would have sufficient firepower to stimulate their economy if growth slowed up too rapidly. That is exactly what they did last September with interest rate cuts and fiscal packages. The market uncertainties quickly abated after the swift Chinese economic measures. The same is happening now with the PBOC fixing the Yuan currency value to a lower level. New Year’s predictions of a cataclysmic market meltdown look like exaggerated scaremongering.
Another major reason for the NZD/USD pulling back to 0.6400 has been a much weaker Australian dollar due to lower oil and hard commodity prices. The CRB commodity index has plummeted 15% to 160 over recent weeks, so it was inevitable that the AUD could not sustain rates above 0.7200 to the USD, and over recent days it has broken below key support levels to trade back to its lows of 0.6850. The NZD/USD rate has followed in tandem to the AUD sell-off, the NZD/AUD cross-rate remaining steady around 0.9400.
In the short-term the FX markets will be looking to the result of two important releases this week, the Global Dairy Trade wholemilk powder (WMP) auction on the morning of Wednesday 20 January and the December quarter’s inflation data (CPI Index), also on Wednesday morning. Rainfall around New Zealand in recent weeks has alleviated El Nino drought risks and thus offshore buyers of our milk powder have held back from aggressive buying at this time. The WMP price decreased by 4% to US$2,210 at the last auction on 5 January. The WMP futures prices still point to price improvement up to US$2,500 over the next six months. A December quarter inflation increases below 0.20% may cause short-term NZ dollar weakness.
Looking further ahead over coming months, it is not expected that lower dairy prices or a stronger US dollar will send the NZD/USD lower to 0.6000. Indeed, despite the Fed’s action to lift interest rates and considerable commodity price weakness, the US dollar has failed to make gains over recent months. The US dollar made gains nine to 12 months ago in expectation of the US interest rate changes in the second half of 2015. It was already fully priced into currency markets in advance, thus those expecting another massive appreciation of the US dollar this year may be disappointed unless US economic growth and inflation suddenly takes off. What is more likely is steady improvement in the US economy, not above market expectations as they stand today.
The “Economist” magazine’s “Big Mac Currency Index” currently calculates the NZ dollar as 14% undervalued against the USD. A year ago when the NZD/USD exchange rate was above 0.8500 the same index rated the NZ dollar at 15% over-valued. Analysis that should not be dismissed!
What we also know is that the free-floating NZ dollar currency is “doing its job” as an automatic shock-absorber and stabiliser for our economy and commodity exporters as the NZD/USD weakened through the second half of 2015 in line with falling commodity prices, leaving the ANZ Commodity Price Index in NZD terms just down 1% over the year.
Recovering WMP prices, relatively stronger NZ economic performance and no more interest rate cuts do not suggest a weaker NZ dollar in 2016. The NZD/USD rate should remain broadly in the mid 0.6000’s with the TWI Index around 70.0.
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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