By Roger J Kerr*
Any chance of a recovery back upwards in the Kiwi dollar’s value has been thwarted over this last week by a stronger USD and sharply weaker AUD on global FX markets.
The Australian dollar has depreciated to 0.7100 against the USD from a barrage of negative news, principally related to weaker Chinese economic data and the Emerging Market sell-off (Argentina, Brazil, Russia, China, Indonesia, India, South Africa).
The Trump administration probably believe they are making progress in pressurising the Chinese to relent on the trade war as the Chinese share market continues to weaken and their economic data softens.
The Aussie dollar has been badly caught in the cross-fire from the escalating trade wars between the US and China, and as highlighted in last week’s commentary, the currency markets are buying the USD against all currencies when the US increases import tariffs.
The continuing tumble in the AUD against the USD has dragged the Kiwi dollar down to 0.6530, below its previous 30 month low of 0.6550 two weeks ago. At 0.7100 the AUD/USD has reached its lowest point since mid-2015.
It has been one-way traffic down for the AUD against the USD over the last eight months since the highs of 0.8100 in January.
What is somewhat surprising is that the depreciation from the 0.7700 area has occurred without any related reduction in the metal and mining commodity prices that the AUD/USD exchange rate is normally tightly bound to (refer first chart below).
Several commentators are suggesting that the AUD is now being classified in the same economic bucket as plummeting Emerging Market currencies such as the Turkish Lire and Argentinian Peso.
That very negative classification of the Aussie dollar and/or the Australian economy seems a very long way away from the reality of their economy expanding by 0.70% in the June quarter (+3.4% annual rate).
Whilst there are a couple of negatives for Australia currently (political merry-go-rounds and the residential property market coming under pressures with increasing mortgage rates), in my view the AUD/USD exchange rate has well under-shot its fair value.
Similar to the speculative futures market positioning in the NZD/USD exchange rate where the Kiwi is at extreme short-sold levels, the speculators are now also heavily short-sold the AUD against the USD as well (refer second chart below).
The currency punters just need a good reason to unwind their positions, buying the AUD to take their profits.
The only potential positive news on the horizon for the Aussie dollar would be some form of concession from the Canadians and Chinese in their trade/tariff negotiations with the US.
President Donald Trump will be looking for some victories to point to ahead of the early-November US mid-term elections for the House of Representatives and Senate. The Republicans and Trump are performing poorly in the political opinion polls, despite the continuing US economic successes of more jobs and rising wages (2.9% increase over the last year, the highest since 2009).
Therefore, political expediency may mean that The Donald dials back some of his extreme trade/tariff demands on the Canadians and Chinese over coming weeks and concedes a little ground to get new deals done. It is all about cementing a deal and looking good for Trump.
The aforementioned analysis on the likely fortunes for the AUD/USD exchange rate over coming week/months is important for the Kiwi dollar and whether it can pull out of the downward slump it has been in since 0.7400 in April.
A recovery in the AUD back to where its driver (commodity prices) suggest it should be, nearer 0.7700, would certainly return the NZD/USD rate to 0.7000.
As the chart below displays, there are not too many occasions historically when the AUD/USD exchange rate radically diverges from its commodity price link.
It is hardly fresh news that the Australian economy is highly dependent on China for import/export trade.
Short-term currency speculation has pushed both the Kiwi dollar and Aussie dollar well below levels that their respective economic/commodity price fundamentals would justify.
It is not easy to predict exactly when and how these miss-alignments will correct themselves.
What we do know is that both FX markets are at extreme short-sold levels and thus a reversal on profit-taking seems more probable than further selling.
In New Zealand’s case, the increase in our Terms of Trade Index (export and import prices) in the June quarter to remain at record 40-year highs is completely at odds with this latest Kiwi dollar sell-off.
If the FX markets are classifying the NZ and Aussie economies/currencies in the same mould as Turkey and Argentina, it is a plainly ridiculous perspective that will not be sustainable. It is only a matter of time before we see the inevitable corrections.
*Roger J Kerr is an independent treasury Management advisor. He has written commentaries on the NZ Dollar since 1981.