Roger J Kerr says interest rates and commodity prices are now key for the Kiwi dollar

By Roger J Kerr

The political risk factor as a driver of the New Zealand dollar’s daily movements is dissipating in the foreign exchange markets.

A strong NZ employment number last week aided the more positive sentiment towards the Kiwi and pulled it back above 0.6900 against the USD.

The new government is getting down to its business and the financial markets are returning to focus on what really drives the NZ economy, which is not the government (no matter who they are).

It is becoming clear that after a six cent plunge in the NZD/USD rate from 0.7400 to 0.6800, the offshore traders, investors and speculators who wanted to get out of the Kiwi due to the shear uncertainty of what the political changes meant for the currency and economy, have now all exited.

The panic selling has come to an end and it is also clear that local exporters have been very active over recent weeks hedging forward their FX exposures at attractive spot rate entry levels and thus buying the Kiwi in the process. 

The risk surrounding the prospect of New Zealand losing some international credibility by the new government not fully supporting the TPPA trade initiative has certainly reduced with statements from PM Jacinda Ardern and Trade & Export Growth Minister, David Parker.

Hopefully their “work-around” for banning foreign investors into existing houses in New Zealand is accepted and does not weaken our international trade position.

Winston Peter’s stance was to pull out of the TPPA and push for a trade agreement with the Russians, who are currently off everyone’s Christmas card list due to the Ukraine. It does not appear that some of these mixed messages on the trade front have influenced the sentiment towards the Kiwi dollar.

Looking ahead, the New Zealand centric variables that determine the NZD/USD movement over coming weeks and months will be:

Changes to RBNZ inflation forecasts:
The RBNZ are currently forecasting the annual inflation rate to reduce to just 0.70% by March 2018 (from 1.90% currently) and then lift to 1.9% by December 2018. Examining a whole host of likely price increase over coming months from currency depreciation, higher wages feeding higher price setting behaviour, higher fuel prices, continuing supply issues holding fruit and vegetable prices up and ongoing construction price increases, the 0.70% forecast may well be closer to 1.70% in reality. The question is whether that major forecast miss forces the RBNZ to increase their 12 to 18-month inflation forecast? Their current loose monetary policy settings will only be changed if they are forced to increase their 12 to 18-month inflation forecast well above 2.00%. Much depends on how the economy performs over coming months. If business and consumer confidence bounce back up, the risk increases that the RBNZ will have to increase their inflation forecasts and bring forward the timing of when the first OCR increase will occur i.e. late 2018, not late 2019. The FX markets will be pricing-in these anticipated economic developments well in advance and for the reasons outlined above, the risk/reward equation for the Kiwi dollar is more up than down.

Export commodity price movements:
The most important economic fundamental for determining the value of the NZ dollar is the very high correlation to our key export commodity prices. According to the ANZ Commodity Price Index, the NZD/USD value today should be closer to 0.7500. Political risk and lower whole milk powder prices have pulled the Kiwi away from its export commodity price linkage for the time being. Global growth forecasts are currently being revised up, therefore the overall outlook for soft commodity prices has to be positive (barring unforecastable climatic events). Fonterra is sticking to their $6.75 milk solids payout forecast, indicating that they have sold more product forward than what perhaps the markets have anticipated. I would expect Fonterra to scale back volumes on upcoming GDT auctions to stabilise the WMP price. I certainly do not see any downside risk for the Kiwi dollar from here due to further large falls in WMP prices.

A return to over 0.7000 appears more likely than further depreciation below 0.6800. However, the near term direction will be influenced by how the RBNZ see the changed economic outlook in their Monetary Policy Statement this Thursday.

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