By Roger J Kerr
The question of “where to from here?” for the Kiwi dollar following the rapid plunge from 0.7400 to 0.7000 over recent weeks is very much on the mind of those financially exposed to NZD/USD exchange rate movements.
As is always the case, a forward view on the Kiwi dollar, by necessity, includes a forward view on the forces that drive movements in the currency value.
Further NZ dollar weakness below 0.7000 cannot be ruled out as the downward momentum remains firmly in train.
We would have to expect buying support for the Kiwi at the 0.6800 level, where it has bounced back up from on several previous occasions over the last 24 months.
On the topside, several factors have changed over recent months that suggest there will be more sellers of the Kiwi attracted to act at a lower NZD/USD level than was previously the case.
The Kiwi dollar has now moved below the previous 0.7150 to 0.7450 trading range and is unlikely to return to that environment until the US dollar itself weakens on global forex markets.
The timing of that forecast USD weakness is scheduled for some time in 2019, after the US interest rate hikes are completed and fully priced-in and the markets re-focus on the size of the US internal budget deficits (USD negative).
A summary of four factors or reasons that suggest an overall lower trading range for the NZD/USD rate between 0.6800 and 0.7200 over coming months are as follows:-
- New Zealand 10-year Government Bond yields at 2.80% are now trading 15 basis points below US 10-year Treasury Bond rates at 2.95%. Offshore holders of NZ bonds have already reduced their proportion of the total outstanding bonds on issue to below 60%. Further reductions are very likely as the yield enhancement incentive to be invested in NZ bonds is no longer there. It will only take one large Asian sovereign wealth fund to wake up and realise that it makes no sense to be in New Zealand bonds vis-à-vis US bonds to cause a sharp market sell-off. The Asian bond investors generally do not hedge the NZ dollar currency risk, therefore they will be selling large amounts of NZ dollars as they exit.
- Dairy prices have remained at elevated levels over recent weeks despite other commodity prices correcting downwards. The tenuous correlation of whole milk powder prices to rising crude oil prices may explain some of this dairy price resilience. A “buy the rumour/sell the fact” situation for oil prices ahead of the May 12 Iranian sanction deadline may well see a reversal in oil prices and thus a downward shift in dairy prices. The plummet in the NZD/USD rate has run ahead of the stable dairy prices to date, however lower whole milk powder prices would still be negative for the Kiwi dollar.
- In recent years the NZ and Aussie Government budget statements during the month of May have generally been NZD positive (larger budget surpluses) and AUD negative (budget deficits larger than anticipated). The Australian budget this week and NZ Finance Minister Grant Robertson’s first budget next week are set to cause a reversal in that previous FX market reaction. Improved Government finances in Australia and a lot of spending demands on Mr Robertson here will see him struggle to live within budgetary limits. Increased Government bond issuance in NZ (higher government debt) will not be what offshore bondholders will want to see. Further selling of the Kiwi dollar against the AUD into the 0.9200’s will pull the NZD/USD rate down.
- The US dollar itself has strengthened from $1.2400 to $1.1950 against the Euro over recent weeks as positive US economic data and US interest rate increases re-exert themselves, whereas European economic data has been soft since the start of the year. We are now witnessing the unwinding of sold USD/bought EUR FX market positions entered in late 2017 when the US dollar lost favour and the markets speculated that the Europeans would be ending loose/loose monetary policy. A return to $1.1500 in the EUR/USD rate would see the Kiwi at 0.6800.
Local exporters in USD need to be progressively lifting hedge percentages to be at maximums of policy limits if and when we get to 0.6800.
It is always easier to hedge on the way down than to make hedging decisions when the Kiwi is rapidly appreciating.
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.