Roger J Kerr says the NZ dollar has experienced one of its most stable periods for many years

By Roger J Kerr

Despite sometimes extreme day-to-day volatility buffeting the Kiwi dollar up and down one or two cents against the US dollar in the forex markets, the overall direction of the NZD/USD exchange rate remains one of sideways movement within the now very well established 0.6400 to 0.6800 trading range.

The relatively narrow four cent range has been in train for nine months now, representing one of the most stable periods for the Kiwi dollar for many years.

Since the NZ dollar was free-floated in 1985 the average annual trading range against the USD from high to low has been 11 cents. The last nine months has therefore been remarkably stable as the positive and negative forces have consistently balanced each other out.

As previously highlighted in this column, the level of offshore speculative or investor interest in the NZ dollar has dropped away compared to previous years. Therefore, market surprises such as the last 0.25% cut in the OCR by the RBNZ are not having the impact on the currency value as they once did.

Looking ahead, it is difficult to see what extraordinary event or development (local or international) would push the Kiwi dollar out of its 0.6400 to 0.6800 band.

The majority of local currency forecasters have been predicting a depreciation of the NZD to below 0.6000 against the USD for over nine months now, citing lower dairy commodity prices and a stronger US dollar as the reasons for that decrease.

The credibility of such forecasts must be wearing thin as the stability in the mid 0.6000’s continues. The situation with international dairy prices and the US dollar value is arguably more complex than the pundits realise.

The recovery in Wholemilk Powder (WMP) prices from their lows of US$1,500/MT last August has been jagged and generally slower than expected. We have yet to see a serious supply response from European WMP producers/exporters to the record low prices. That will, however, eventually come and the supply/demand imbalance will right itself. Current WMP futures pricing point to modest increases from US$1,950 to US$2,150 by July and US$2,350 by December. The dairy commodity price influence on the Kiwi dollar from here is mildly positive, not negative.

The US dollar made its gains on global FX markets in expectation of rising US interest rates from mid-2014 to mid-2015. The currency markets had already built in rising US interest rates into the USD value well ahead of the first increase by the Federal Reserve in December 2015. Since that time, both the US interest rate markets and the Fed have tempered back the pace of interest rate increases and therefore over recent months the US dollar has lost ground against the Euro and Yen. The much vaunted bout of US dollar strength has not occurred over the past nine months as it had already happened over the 12 months prior.

Whilst the US dollar may have already appreciated some time ago on the anticipation of higher US interest rates and continuing negative interest rates in Europe, the recent selling of the USD to $1.1300 against the Euro does not look too sustainable. US economic data continues to be much more positive than anything coming out of Europe. The fourth quarter 2015 GDP growth was recently revised upwards from +1.00% annualised to +1.4% on the back of stronger consumer spending. Monthly employment growth in the US continues at a robust pace, so there is nothing at all to suggest that US economic recovery is faltering.

Likewise, the widely forecast “hard landing” (a rapid decrease in growth rates) for the Chinese economy has just not happened with the Chinese monetary and fiscal authorities delivering the right amount of timely stimulus to maintain their annual growth above 6.5%. Latest profit data from the Chinese manufacturing sector was up a healthy 4% in January/February. The prospect of an economic or credit shock out of China disrupting global financial/investment markets and the world economy and thus sending the NZ dollar down does not look at all likely anytime soon.

The more probable direction of the EUR/USD exchange rate over coming months is for the USD to strengthen from $1.1200 back to $1.0600. Such a 5% USD appreciation would pull the NZD/USD rate back to the 0.6400/0.6500 region, however no lower.

The Australian dollar has outperformed the NZD against the USD of late as their metal and mining commodity prices have increased, whilst WMP prices have remained near their lows. How sustainable the increase in hard commodity prices is remains to be seen. Global demand has not exactly lifted and the IMF will be lowering their global economic growth forecasts again within the next two weeks. The AUD has raced up from 0.7100 to above 0.7600 against the USD on the commodity price lift, however it appears to be over-cooked and a return to the 0.7300/0.7400 area is on the cards. The AUD correction would also pull the NZD lower from its current 0.6720 level.

Counter-balancing the potential USD and AUD negatives for the Kiwi over coming months will be a potential surprise with the December 2015 quarter’s CPI inflation result on April 18.

The exchange rate impact on imported consumer goods and the latest lift in oil prices are likely to deliver a quarterly inflation increase well above the RBNZ’s forecast of just +0.20%. Expectations of further significant interest rate cuts in NZ may be dashed on such an outcome.

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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

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