Roger J Kerr wonders if it will again be a case of 'up by the stairs and down by the elevator shaft' for the New Zealand currency

By Roger J Kerr

Having retreated from 0.7300 to 0.7000 on a RBNZ change of heart, what will drive the NZD/USD exchange over coming months from current levels?

The FX markets have already largely priced in a 0.25% cut in the OCR on 11 August and the potential for another 0.25% cut to 1.75% following that. Outside of NZ monetary policy signals/settings and thus interest rate levels relative to the rest of the world, the following variables, forces and events should now take over as Kiwi dollar determinants:-

• A continuation of renewed US dollar strength in its own right does seem highly likely. US economic data has certainly been stronger in the second quarter and even though the US interest rate markets are not pricing a Federal Reserve rate hike in September, the probability of a lift has to be increasing. The overall USD Currency Index has appreciated from a low of 93.00 two months ago to 97.3 today. The EUR/USD rate has reduced to below $1.1000 and further USD strength to $1.0750 and below has to be expected as inflation and growth remain super low in Europe, in contrast to much higher inflation and growth in the US economy. The US Presidential election campaign and result is not really expected to influence the value of the US dollar – what Janet Yellen does at the Fed is much more important. A 5% appreciation of the USD against the EUR to $1.0500 could see the NZD/USD rate three cents lower to 0.6700 – all other influences being equal.
• Whether international dairy prices can lift off the bottom, or not? There are some reports that milk production in Europe may finally be reducing (or not increasing as much as expected) in response to the very low prices. The traded market remains sceptical and appears to be waiting to see what the new NZ season’s volumes will do to prices. Recent GDT dairy auction results have been flat across the page, however the futures forward pricing is still higher at US$2,350/MT for December WMP (current spot WMP is US$2,080/MT). Another plunge lower in WMP is not looking too likely, so no depreciation for the NZD from this source.
• New Zealand economic financial and economic news could be a very mixed bag over coming months. The growth momentum in the economy outside of the dairy sector looks set to carry on, even though home mortgage borrowers may be disappointed at the banks not fully passing through OCR cuts to lending interest rates. The RBNZ Survey of Inflation Expectations result on 2 August should be another low one and be seen as a NZ dollar negative. The expected media headlines of large indebted dairy farming entities being in financial strife has yet to materialise. The bank are not yet breaking ranks on preventing the release bad news stories in this respect. Dairy farm land prices are down 18% and dairy incomes are below costs for the third year (for those with debt costs). It does not take Einstein to work out that lending covenants are being severely breached. It is only a matter of time before the dairy debt crisis hits the headlines and when that happens the offshore response will be to sell the NZ dollar.
• Global investment market sentiment and related capital flows are always a factor for NZD/USD direction. “Brexit? What Brexit?” has been the response of financial and investment markets over recent weeks as share indices soar back to new highs. The NZD/USD has not followed the equity markets higher as the RBNZ changed their tune last week. The investment markets have not had a shock since January when weaker Chinese data and plummeting oil prices worried the herds. During the Olympic Games and northern hemisphere summer holiday period it seems that global markets will drift over coming weeks with no clear direction. The question for the Kiwi dollar is whether international yield seekers have been put off by the upcoming RBNZ cutting of the OCR? If these capital inflows into NZ reduce in volume, the Kiwi dollar can easily drop another cent or two on the actual OCR action in two weeks’ time.

If you believe the well proven pattern that the Kiwi dollar always goes up the stairs and down the elevator shaft, we could well see rates of 0.6700 and 0.6600 sooner rather than later.

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