By Roger J Kerr
The NZD/USD exchange rate has been back above 0.6800 again. Over the past eight months the Kiwi dollar has failed to sustain gains to above 0.6800. Will this occasion be any different to the patterns of the past?
I suspect not, as we approach an important Reserve Bank of New Zealand prognosis of the economy, outlook and monetary policy settings this Thursday.
The RBNZ will not want to deliver a message or signal that would push the Kiwi dollar any higher, particularly, as all their warnings about the currency being still too high have been ignored by the financial markets to date.
Given that the RBNZ tone this Thursday is likely to be on the dovish side, one would have to expect that the FX market would not want to be holding long NZD positions over the next few days.
A return to the 0.6600 area is on the cards in the short-term, ahead of and after the RBNZ statement.
It is fascinating to observe that since one of our major banks changed their mind a week ago and now forecast two 0.25% OCR interest rate cuts this year, the Kiwi dollar has appreciated. Either the currency markets do not agree with the majority of local banks’ viewpoint that further monetary policy easing is inevitable or there are greater forces at work. I believe it is the latter reason, with a stronger Australian dollar and weaker USD over recent days propelling the Kiwi dollar to 0.6800.
Just to prove that foreign exchange markets are as bizarrely irrational and illogical as ever, the US dollar weakened on Friday following the stronger than anticipated US employment figure.
Normally the USD would make gains on such an outcome as the case for higher interest rates is strengthened. However, instead the FX market sold the USD as they focused on a pullback in the increase in wages and weaker US overseas trade data that confirmed that some major US exporters are struggling to be competitive with the stronger US dollar over the past 18 months.
I would not see the EUR/USD rate staying at $1.1000 for long ahead of the ECB’s plan to ease their monetary policy further at their review this Friday.
We still favour the EUR/USD returning to $1.0500 on the contrasting monetary policy settings on either side of the Atlantic.
Therefore a stronger USD against the major currencies should pull the Kiwi dollar back to the 0.6500 region over coming weeks.
The AUD has made some spectacular gains against the USD from 0.7100 to 0.7400 over the last two weeks, therefore some profit-taking (i.e. AUD selling) has to be expected despite a continuing flow of positive Aussie economic news. Some pundits are citing the reason for the recent AUD gains as being due to contrarian/counter-cyclical buying of commodities at their record lows by hedge funds. Often the AUD currency is used as a surrogate for commodity price plays by investors/speculators.
Whilst all parts of the NZ economy outside the dairy industry are enjoying reasonably buoyant trading conditions in early 2016, it cannot be very long before some of the cashflow/credit tensions and difficulties dairy farmers are now experiencing hit the media headlines and impact on the Kiwi dollar.
Stories of sharemilkers abandoning their cows and walking off farms are already about, and the bank lenders are starting to take a firmer line on overdraft limits.
The RBNZ will need to paint one potential doomsday scenario for the economy based around a third year of low milksolids payout amounts. That scenario appears unlikely to me, however, the risk cannot be ignored. Wholemilk powder futures prices continue to point to price improvement to US$2,300/MT by mid-year from the current US$1,900/MT level. Dairy farmers will be hoping the NZD/USD exchange rate moves in the opposite direction to the recent appreciation to 0.6800.
Governor Wheeler will be choosing his words carefully for his statement on Thursday to give the currency a nudge 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