Roger J Kerr says RBNZ Governor Graeme Wheeler should take his cue from across the Tasman on the timing and finesse of interest rate movements

By Roger J Kerr

Economic and political developments in Australia are playing a major role at this time in influencing the value of the Australian dollar, hence the NZ dollar as well. A surprise cut in the OCR by the Reserve Bank of Australia (RBA), subsequent lower inflation forecasts from the RBA and the Aussie Federal Budget last week have changed the market sentiment and reversed the direction of the AUD on the FX markets.

The AUD/USD rate has dived 5.5% from highs of 0.7800 two weeks ago to 0.7370 at the time of writing.

Speculative buying of the Aussie dollar in February and March was based on the associated buying of commodities and the fact that Australia still offers some yield return with its interest rates in a world of zero yields in many parts. The AUD had raced higher on hot air and it was always susceptible to a sharp fall once the direction changed.

The catalyst for the reversal was the OCR cut. Once again the RBA has caught the market napping and played a master-stroke in terms of timing and effectiveness in bringing the AUD value down.

The currency markets will now be focused on the upcoming Australian general election on July 2nd.

The political opinion polls are very close and there is doubt whether PM Malcolm Turnbull will achieve the clear mandate he seeks. It appears that an independent member could again hold the balance of power in the Senate upper house, making it more difficult for the Australian Government to make economic policy changes to address the large annual budget deficits.

The Australian dollar should continue to be under downward pressure over coming weeks as the political/economic uncertainty plays out. Moreover, the credit rating agencies are likely to comment that the Australian sovereign rating will also be under pressure as spending cuts and tax hikes are not implemented to reduce their fiscal deficit.

The NZD/USD exchange rate has tracked the AUD/USD lower to some extent. However, the selling has not been as concentrated, resulting in the NZD/AUD cross-rate moving up sharply from below 0.9000 to 0.9260.

At some point the NZD will catch up to the AUD weakness, it just requires a trigger to start the selling momentum.

The RBNZ missed the opportunity to drive the Kiwi dollar lower two weeks ago when they kept the OCR unchanged.

Governor Wheeler should be looking across the Tasman to see how it is done in terms of timing finesse and tactics.

The RBNZ continually talk of the need for a lower NZ dollar to get inflation back into the 1% to 3% band, however their decision making, messages and action in December, March and late April have resulted in the markets pushing the Kiwi dollar higher, not lower!

Unless there is surprisingly strong local economic data over the next month, the RBNZ will be cutting the OCR again on 9 June.

The interest rate differential (two year swap interest rate) between Australia and New Zealand points to a 0.8600 NZD/AUD cross-rate, therefore at some point not too far away FX traders will take the opportunity to sell the Kiwi dollar against the Aussie at rates above 0.9200. The selling from this source should pull the NZD/USD rate lower from above 0.6800 to the 0.6500/0.6600 region again.

Whilst the US economy recorded its lowest monthly increase in new jobs during April for seven months, the US dollar was not sold on the disappointing employment news.

Compensating the weaker jobs outcome was the fact that wages increased 0.3% in the month with the annual wages growth now up to 2.5%. The rule of thumb in the USD is that wage increases need to lift to above 3.0% to keep annual inflation well above 2.00%.

Yet again the US dollar has found some support at the $1.1400 level against the Euro and any improvement in the USD in the weeks ahead will add to the lower trajectory of the Kiwi dollar.

The EUR/USD exchange rate has been to $1.1400 on two previous occasions over the last 12 months, only to stall and reverse back to $1.0800 each time. It is expected that the Euro will again fail to hold onto its gains as Euroland economic growth and inflation remain near to zero.

The Euro weakness against the USD over coming months is forecast to be greater than NZD reductions against the USD, resulting in a rising NZD/EUR cross-rate from the current 0.5980 level.

Local exporters selling their products in Euro and Yen should be taking the opportunity to extend their hedging programmes at current spot and forward rate levels.

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