Roger J Kerr says unless you firmly believe that the US dollar is about to take off and dairy prices are about to collapse, it is hard to fathom how forecasts of the NZ dollar falling to US60c will be proven to be accurate

By Roger J Kerr*

Just when it looked like the Kiwi dollar was in a reasonable recovery mode last week (climbing to above 0.6700), yet another US trade/tariff development gazumped its gains.

The failure of the US and Canada to agree on a re-drafted NAFTA trade agreement at last Friday’s deadline date sent the Canadian and Australian dollars tumbling on global currency markets.

The Australian dollar has been out of favour with international investors for quite a few months now and any escalation in the trade wars between China and the US has been negative for the AUD. Adding to the negative sentiment for the Aussie has been weaker Chinese economic data and the revolving door that is political leadership in Australia.

In the absence of any local, independent positive or negative news for the NZD/USD rate on its own account, it tracks the AUD/USD exchange rate in day-to-day financial markets trading.

The Aussie dollar rate has been sold down to new three-year lows of 0.7190 against the USD, allowing the NZD/AUD cross-rate to lift to a two-month high of 0.9205.

The NZD/USD decreased one cent to 0.6620, however less than the 1.5 cent drop in the Aussie. The short-lived dip in the NZD/AUD cross-rate to 0.8960 in early August was certainly a golden hedging opportunity for local exporters in Australian dollars who had orders placed in the market to buy NZD against the AUD.

There may be some better news for the Aussie dollar over the course of this coming week with their second-quarter GDP growth data released on Wednesday. Prior forecasts are for the Australian economy to expand by 0.70% to 0.80% for the June quarter.

Certainly, the lower AUD/USD exchange rate is driving renewed profitability and investment in their resources sector as it has generally not been accompanied with decreasing metal and mining commodity prices, as is usually the case. A GDP growth result at, or better, than forecast should cause AUD buying on profit-taking.

The pattern in global currency markets over recent months has been for the US dollar to strengthen against all currencies when it appears the Trump-induced trade wars are escalating in intensity and economic impact.

However, the USD is prone to weakness when some progress is made in trade negotiations and debilitating import tariffs seem less likely.

The USD weakened when the US and Mexico agreed new trade terms last week, however the USD regained ground when the US and Canada talks failed to reach any initial agreement.

Trump continues to upset the Europeans with threats of tariffs on their car imports into the US.

The EUR/USD exchange rate has returned to $1.1600 after the USD weakened to $1.1700 on the Mexico deal. Problems in emerging market economies were highlighted again last week with the Argentinian Peso crumbling as they asked for an extension on their IMF loans.

The NZD and AUD tend to weaken when there are sell offs in emerging market currencies. The relationship hinges around the sharp depreciation in the emerging market currency allowing their exporters to accept a lower USD price for their export commodity i.e. lower commodity prices, which is never positive news for “commodity currencies” like the NZD and AUD.

On the home front, there has been a ton of media space given to the Labour Coalition Government’s refusal to accept that the collapse in business confidence is real or anything to do with them.

My recent view has been that the very low business confidence levels have already been fully priced into the lower NZ dollar currency value and therefore future survey results would not have any great impact on the NZD/USD exchange rate.

That view was squashed last week as the Kiwi dropped half a cent when the ANZ business confidence survey for August produced further declines.

However, as the Prime Minister Jacinda Ardern was stressing at an address to business folk last week, the headline business confidence index has no casuistic correlation with subsequent actual GDP growth.

Unfortunately, her economic advisors were mischievously selective in only singling out the headline index “what is your forward view for the overall economy” and not mentioning that the secondary and preferred “firm’s own activity” index has a very high and reliable correlation with subsequent GDP growth in the NZ economy.

Most economic analysts and commentators highlight the connection between business firms’ forward view on their own activity levels and economic expansion (or lack thereof) as it translates directly into business investment decisions.

The current level of the “firm’s own activity index” points to annual GDP growth slowing to less than +1.0% pa.

The PM’s economic advisors may want to have a close look at the chart below, as the only time the “own activity” business confidence index has diverged from GDP growth over the last 30 years was in 2015 when dairy commodity prices collapsed, and GDP growth slumped unexpectedly. No-one picked that commodity price fall in advance and the RBNZ Governor at the time, Graeme Wheeler was forced to reverse OCR increases into OCR cuts in response.

Important local economic data to watch out for this week will be the Terms of Trade index for the June quarter on Monday 3 September and the Global Dairy Trade auction results on Wednesday morning 5th September.

The continuing high level of the Terms of Trade Index (export and import prices) will highlight once again that the NZD/USD exchange rate at 0.6600 is well below the value that its predominant determinant (export commodity prices) suggest it should be at (refer second chart below). As NZ dairy production moves into the new season, the global demand/supply position for whole milk powder should start to emerge. It is hard to locate a forecast that suggests whole milk powder prices are moving substantially lower than the current US$2,900/MT level.

Many currency forecasters continue to predict that the NZ dollar will depreciate further to near 0.6000 over coming months. Unless you firmly believe that the US dollar is about to take off and dairy prices are about to collapse, it is hard to fathom how such forecasts will be proven to be accurate.

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*Roger J Kerr is an independent treasury Management advisor. He has written commentaries on the NZ Dollar since 1981. 

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14 Comments

Again Roger, no recognition of how the markets may be viewing levels of private household indebtedness. An economy is not purely built on the price of what comes out of a cows udders. Nor is an exchange rate. We're on the way to sub US 60 cents because household confidence is the real driver of consumption based economies - and when a house starts leaking equity, confidence is battered and consumption reduces as people feel less inclined to 'milk' the house for cash.

Yes quite. Would be interesting if RBNZ produced a stat showing NET mortgage advances per quarter - ie to indicate what people are paying off (reducing money in circulation). Also, concentration of house ownership and hence borrowing leverage, is at older end of spectrum. This, in time, means less spending due to propensity being lower as ageing progresses. In a FIRE economy like NZ, RE should be looked at more closely. Money supply growth has slipped from 9% to 6.5% in last 2 years and Chinese rich are now chary. Watch the OB ban accelerate this in Auckland.

mikekirk29. The OB ban will devastate the Auckland housing market and the aspirations of all those who were planning their evacuation/retirement to cheaper areas.

The capitulation has already started; the FONGO runs deep in Kohimarama. Listings on Trademe have dropped 10% from last week, to 17. That represents 0.57% of all dwellings in the area. It's going to be a cold wet Spring for the agents and the 99.43% of owners desperate to escape but without the willingness to accept prices are back at 2002 price levels /sarc

Kohimarama is a very small world to worry about I guess! Was it really worthy of the post? or is it just a microcosm of your general concern?

I couldn’t be bothered flicking back to your posts last week with overall NZ sales numbers so I used ones I knew i.e. my suburb. I’m sure you can fill us in on the Nationwide trend where you were telling us about an avalanche of listings.

Edit. I got bored and went back. On 21/8 you were citing a cascade of listings, then standing at 30,407. 13 days later it’s risen by 53 listings. You must be happy with the trend if nothing else.

Why is NZD falling "so much" against US dollars?? Let me have a go:
QE ended. QT instead. USA growth and inflation figs and interest rates all high to rising. NZ GDP doing opposite - it is tanking. NZ economy is commodity and China dominated. China will lose trade war to US (as usual, everyone does) Fewer dollars being circulated and produced so price goes up. Safe haven status. By the way, are WMP all NZ has? Better get off the China teat as they are looking to reduce export dependency and esp in respect to food production. So much (HA) for diversification. Also, you might have noticed that governor Orr and his chief economist gave markets a big sell signal on currency over past 3-4 weeks and interest rates are stated to be headed down next - hardly a support for NZD is it??

Excellent text re effect of housing debt and land issue on modern Western economies is:

"Re-thinking the economics of land and housing", 2017: Josh Ryan-Collins; Toby Lloyd & Laurie Mcfarlane
Zed Books Ltd

Try the 5 or 10 year NZ/US swap rate spread vs. the NZD, then it will all make sense! Not the 90 day rate like last time. The yield spread is going to keep growing for a while yet and therefore the NZD will probably go much lower. As said previously, below 65 cents by year end and sub 60 cents during 2019 seems likely.

You can't afford to not fathom these outcomes as possible if you're in the business of advising currency hedge positions.

After all, hedging is done because we DON'T know what the future holds, not because we do know what the future holds. It's not about saying let's hedge now because the currency will rise. It's about saying we can live at current levels and we want to protect ourselves at this level.

If the NZ economy is heading south like you all say why is our swap rate so high? nearly 90pts. When on the other hand the shortening in the US spread is seen as a prediction of recession coming.

There is literally only one reason why the NZD has fallen so much. It is interesting to see that nobody can quite figure it out, including, consistently so, the author.

Have a think why everyone is scratching their heads over this one..? Nobody really knows why.

There is a reason

Edit: Another point which is pretty silly, is that if dairy prices were actually going to collapse, the Kiwi wouldn't go to 60c, it would be 50% lower than today, no questions asked.

Another factor that influences the value of the NZ dollar is the status of the current account. In most years since about 1971 NZ has had a significant current account deficit - ie we are living beyond our means and have done so for nearly 50 years, hence rising claims on NZ from individuals and companies from overseas, which is reflected in the large outflow of cash in interest and dividend payments to overseas banks and companies.. The CA deficit is about 2.6-2.8% of GDP this year - in some years it has been in excess of 4% of GDP or worse. If more attention was paid to the consistently negative state of our current account, it may well push the NZ dollar lower. In theory at least the exchange rate should adjust to the point where the CA is eliminated - other things being equal, which of course they are not.

https://tradingeconomics.com/new-zealand/current-account?embed
(If you go to the bottom of the chart and click Max and column you get a clear view of the CA from the early 1970s)

https://www.stats.govt.nz/news/record-imports-push-current-account-defic...

The $NZ drops when more people sell then buy. Which forces savings to rise as foreign goods cost more. Our stuff also gets cheaper and so the flow reverses along with the price. That's why it called a floating currency and it's a good thing to.