By Roger J Kerr
It was expected that the NZ dollar would depreciate back to the 0.6500 area against the USD on the RBNZ delivering a dovish monetary policy statement last week, as the RBNZ could not do anything else but jawbone the currency lower to get inflation rising again.
That prior expectation was a long way off the mark.
The RBNZ surprised everyone with another 0.25% cut on the OCR.
The Kiwi dollar reacted in the forex markets as could have been expected, tumbling from 0.6800 prior to the statement to a low of 0.6625. However, three days later the NZD/USD rate has recovered strongly to trade back up to 0.6730.
The resilience of the Kiwi dollar in the mid-0.6000’s region has again been demonstrated. It has weathered a surprise cut in the OCR to 2.25% and does not look like a currency that has problems that would cause further major depreciation.
The RBNZ will be confused and frustrated that their surprise attack on the markets has had minimal impact on the currency. Their primary objective in cutting the OCR much earlier than generally expected would have been to drive the NZ dollar lower as they need price increases on imported goods to get the annual inflation rate back up to between 1% and 3%.
The RBNZ’s ambush on the Kiwi dollar has not worked for three reasons:-
- FX markets are more focused on other forces than just interest rate differentials. An OCR at 2.25% or 2.00% still places New Zealand with an attractive yield return (same as Australia) compared to Europe and Japan.
- The NZ economy in expanding at an annual growth rate near to 3.00% and thus continues to outperform most others. It is not an economy that needs a lower currency value to engineer growth.
- As has been often stated in this commentary over recent months, the offshore hedge funds, traders and speculators are not playing in the NZ dollar any more as the volatile equity markets at the start of the year caused such investors to reduce market risk positions.
The FX market participants who immediately dumped the Kiwi dollar on the RBNZ surprise cut, were very quickly forced to buy back their short-sold positions as the follow-through selling to take it lower did not eventuate.
The RBNZ have therefore, not so far, seen the benefits of their surprise action.
Time will tell if the risks around reducing NZ interest rates further come back to haunt them.
If the banks lower mortgage lending rates and the residential property boom is stoked up further, the economic fall-out from the bubble bursting badly could be blamed back on the perpetrators (the RBNZ). However, the sharp increases in bank borrowing margins in wholesale debt markets over recent months may mean that there is minimal pass-through from the OCR cut to lending interest rates.
Local exporting companies selling into the Australian market in Aussie dollars are thanking RBNZ Governor Graeme Wheeler for the overt monetary policy changes. The NZD/AUD cross-rate dived from rates above 0.9100 last week to lows of 0.8860 as the Kiwi depreciated against the USD, whereas the AUD made gains on the back of higher metal commodity prices.
Most AUD exporters had FX orders placed in the market to transact hedging contracts. Patience has paid off those managing this NZD/AUD currency risk as many companies were holding back from any hedging when the cross-rate was in the 0.9300/0.9400 region just a few short weeks ago. The depreciation in the NZD against the AUD to 0.8900 brings the rate back in line with what the interest rate differentials have been pointing to for several months now. Yet again, the differential between New Zealand and Australia’s two-year interest rates has proven to be a very reliable and accurate lead-indicator for the NZD/AUD cross-rate.
ECB head Mario Draghi last week appears to have suffered from the same mistake RBNZ Governor Wheeler made last December. In reducing interest rates and then projecting that further cuts are unlikely, both men sent their respective currencies higher rather than the desired depreciation. The Euro appreciation to $1.1140 against the USD does not look sustainable however as the Draghi comment may have been misinterpreted and US economic data still points to further US interest rate increases around mid-year.
The RBNZ has a forecast of the New Zealand Trade Weighted Index (TWI) decreasing to the 69.00 area in 2017 and 2018. The modest 4% depreciation from the current TWI level of 71.80 over that time period is not a large change which leaves the NZD/USD rate in the mid 0.6000’s area. At 0.6500 the NZD/USD exchange rate is neither overvalued nor undervalued. An eventual recovery in Wholemilk Powder prices to above US$2,500/MT would place the Kiwi dollar closer to 0.7000 than 0.6000 in the medium term.
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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