By Roger J Kerr
If the New Zealand dollar was a share price on the NZ economy it would be under a firm “buy” or “hold” recommendation from analysts and brokers at this time as the underlying earnings performance and earnings outlook are very positive indeed.
For the NZ economy the release last week of the Terms of Trade Index (export and import prices) confirms the extremely upbeat position of the fundamentals that drive the economy.
The Terms of Trade Index surged another 5.1% over the March quarter to an index level of 1433, just shy of the highest ever level of 1438 recorded in 1973. Since the Terms of Trade Index commenced in 1957 the average level has been 1058, so the earnings power of our current high export prices is really exacerbated right now as import prices (largely oil) remain subdued. The dramatic recovery in dairy commodity prices since January, coupled with higher international market prices for beef, sheepmeat and forestry products is behind the improvement in the Terms of Trade Index.
Off the back of the NZ Government’s budget two weeks ago and the aforementioned boost from higher export prices, it cannot be too surprising that the Kiwi dollar as a surrogate share price on the NZ economy has appreciated in value in response.
The RBNZ sent the Kiwi dollar down to a low of 0.6822 on 11 May when they maintained their guidance of the OCR interest rate not being adjusted to well into 2019.
The markets were pricing a mid-2018 increase for the OCR, however the RBNZ were adamant that annual inflation would reverse back down to 1.1% by March 2018 from the current level of 2.2%. We said at the time a month ago that the FX markets would deliver the verdict on the RBNZ’s benign inflation view. The Kiwi would go lower if the FX markets agreed with the RBNZ’s lower inflation outlook and the Kiwi dollar would appreciate if the FX markets disagreed.
Since that time the NZD/USD exchange rate has climbed in spectacular fashion to highs of 0.7146 on 2 June.
The verdict is clear, the NZ dollar gains reflecting the stellar NZ underlying economic fundamentals (surging export commodity prices) with the FX markets relegating the RBNZ’s inflation forecast as unlikely to be accurate. The Trade Weighted Index of the NZ dollar has rebounded sharply from lows of 75.0 a month ago to pushing 77.0 today.
However, the Kiwi dollar like all share prices, is not just determined by the underlying earnings performance and outlook. Listed company share prices can still go down even when their profits and profit forecasts are up.
Investors into the shares could well be selling out for their own selfish reasons that have nothing to do with the performance or future value of the company. The same market reality applies to the NZ dollar, overseas investors and holders of the Kiwi dollar may well be sellers over coming months even though the NZ economic fundamentals are the best going around.
For these periphery reasons the NZD/USD rate may struggle to make further gains above 0.7150 (and the TWI above 77.0) in the lead up to our general election in September.
Potential reasons as to why offshore Kiwi dollar players are more likely to be sellers rather than buyers over coming months include:-
- All the positive economic news is out and known, thus already fully priced into the rate at 0.7150. If fresh economic news cannot get any better than it already is, new Kiwi dollar buying will not happen.
- The NZD/AUD cross-rate has roared up from 0.9200 to 0.9600 without correction. Speculators who have been long Kiwi and made excellent gains will be unwinding positions on profit-taking from here i.e. independent Kiwi dollar sellers. The historical pattern of rapid gains and equally rapid falls in this cross-rate is likely to repeat.
- Political risk around a possible Labour/Greens Government come September will deter Kiwi dollar buyers and stimulate profit taking.
- The US dollar itself has been weaker against the Euro over recent weeks to $1.1275. Another interest rate increase by the US Federal Reserve next week will remind the global FX markets of the superior US economic performance over Europe. A recovery in the USD is expected. The focus will be on the Fed’s outlook for 2018 and the forward guidance on the speed and number of future interest rate increases. A USD recovery against the Euro will limit further NZD gains against the USD from a general currency market perspective.
Roger J Kerr contracts to PwC in the treasury advisory area. 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