Global financial and investment markets remain in complete turmoil with investor confidence shattered and Governments doing whatever it takes to restore some confidence and stability. Economic recession looms for the OECD countries as the banking and credit crisis takes its toll. The authorities are working hard to unfreeze the credit markets, but when banks cut their counter-party credit limits on each other by so much, the whole plumbing works that allows money in an economy to move around is dislocated. The access to credit and the flow of money are such fundamental parts of the operations of any economy, it is easy to see why Governments everywhere are going to extraordinary and unprecedented measures to restore the plumbing. It seems the Governments will also have to guarantee inter-bank lending as well as retail deposit funds to restore stability. The Australians have done this, the European are heading that way, but the Americans feel they have probably down enough to bail out the banking market. What does all this mean for the NZD exchange rate value? The forex markets are always very quick to deliver their verdict when economic and investment conditions fundamentally change. The verdict of global foreign exchange markets over recent weeks has been to trash the Australian dollar. The dependence of the Australian economy and currency on metal and mining commodity prices has been very clear to see as the AUD has plummeted 35% from above 0.9500 to the USD to lows of 0.6500 in three months.
Commodity prices as measured by the CRB index have fallen 35% (465 highs in June to 300 today) as the speculators in commodity market are forced to unwind long commodity price positions. The speculative trading that took oil and commodity prices to record highs earlier in the year have now reversed with vengeance. Latest IMF forecasts are for OECD GDP to grow at 0.0% over the next 12 months (i.e. recession), developing nations including China and India at 6%, leaving global growth at a very low 3%. The speed of the plunge in the AUD exchange rate and the wild daily volatility does justify direct intervention by the Reserve Bank of Australia to buy and stabilise their currency. Dysfunctional and disorderly markets are a pre-requisite for intervention and it would not be surprising to see the RBA move. Governments and central banks are entertaining all sorts support action for their banking systems. The Australian government is guaranteeing the Australian banks who borrow from international markets. The NZ arms of those banks do not have such a guarantee. A reasonable bounce up in the AUD against the USD has to be expected after the 30 cent collapse. One dramatic consequence of the dumping of the Aussie dollar by global investors is a sky-rocketing of the NZD from 0.8200 against the AUD a week ago to highs of 0.9200. The efficacy of prudent currency hedging policies for local exporters in AUD's has been underlined by this massive cross-rate realignment. It is a reminder than anything can happen in foreign exchange markets, that no-one predicts. It has just happened in the NZD/AUD cross-rate. Should RBA intervention cause the AUD to recover back to 0.7000 against the USD, the NZD would stay below 0.6000, sending the NZD/AUD cross-rate back to 0.8500 very quickly. Our twin deficits put 0.6000 "fair equilibrium value" under spotlight As anticipated, the USD continues to be the reserve currency for the world and is where investors head for in times of turmoil and trouble. The Japanese Yen has also strengthened as Japanese investors return funds home from foreign shores in turbulent times. The Uridashi and Euro-Kiwi markets have dried up due to a lack of demand for new issues. Existing Japanese investors in AUD and NZD denominated Uridashi bonds are now recording substantial FX losses on their investments. The level of 0.6000 in the NZD/USD rate is the area that many people have seen in the past as a "fair equilibrium value" for the currency in terms of economic fundamentals and where both importers and exporters can compete and be profitable. New Zealand's economic fundamentals are arguably weaker today than at anytime since 2000. We now have twin deficits with the Government's budget turning rapidly from surplus to deficit and the Balance of payments Current A/c deficit remaining a very negative measure of economic health. Credit rating agencies should be re-examining New Zealand's sovereign rating in the light of this deterioration in our economic position. Excessively tight monetary policy in from 2004 to 2007 caused the recession we are now in. Many manufacturing exporters left town in that period, never to return. The economic damage has been considerable. With much lower interest rates now prevailing in New Zealand, it will need major new economic policy changes to return the nation to positive GDP growth. A change of Government may provide the opportunity to implement the much needed reforms. Only then will the NZ dollar show any sign of individual strength. In the meantime, a strong USD and weak AUD should keep the NZD at or below 0.6000. *Roger J Kerr runs Asia Pacific Risk Management. 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