Kiwi dollar backs off as global markets reverse

By Roger J Kerr

Sentiment and direction have yet again turned in international financial and investment markets over this past week and the NZD/USD exchange rate has also reversed back to 0.7050 from highs of 0.7400.

The markets, particularly the US sharemarket, were expecting the US Federal Reserve to add additional monetary stimulus to the US economy last week, however they were disappointed as the Fed merely extended existing settings for a further period.

The Federal Reserve is very uncertain as to how the US economy will perform over the next 12 months, but they did not take the extra step to loosen monetary conditions further.

As a result the Dow Jones Index reversed its previous gains and the US dollar gained from $1.3200 against the Euro to $1.2800. The Australian and New Zealand dollars followed the weaker Euro movement.

Yet again the Australian dollar has been unable to hold onto gains above 0.9000 against the USD.

The main driver of the AUD/USD rate is metal and mining commodity prices.

Weaker PMI (Purchasing Manger’s Index) indicators in China and elsewhere have stopped the advance of the hard commodity prices. The CRB Index has returned to 268 from 274 a week ago.

The recovery of the USD against all the major currencies has also been negative for commodity prices as the USD currency and commodity prices have an inverse relationship. So it is no great surprise to see the Aussie dollar back off.

The election in Australia is less than a week away, however whatever the outcome the markets do not expect any major changes to economic policy. A return of the ruling Labour Government does seem likely, albeit with a much reduced majority. In this politically-charged environment there is a degree of uncertainty that is more likely to cause AUD selling rather than buying, however a major move down in the Aussie is not expected from this source.

The weaker manufacturing and industrial economic data globally over recent weeks must prove to be more negative for commodity prices, thus negative for the Australian dollar as well over coming weeks.

The Kiwi dollar will follow the AUD lower, maintaining a stable NZD/AUD cross-rate just under 0.8000.

So it appears the Kiwi’s foray above 0.7000 will again be relatively short-lived.

A return to the 0.6700/0.6800 area will be of much relief to the export sector.

The day-to-day movements of the NZD/USD rate are still driven by international currency, share and commodity markets.

Local New Zealand economic developments are having little impact.

As has been stated previously it appears that only two events could force the NZ dollar down on its own accord, independent of global financial/investment market movements. A complete collapse of the international wholemilk powder price would be seen as negative for the NZ economy and the NZ dollar. Likewise a surprise decision by the RBNZ not to increase the OCR in mid-September when the markets are anticipating another 0.25% increase would also send a very negative message about the state of the NZ economy and the Kiwi dollar would be sold down.

Neither of these two events have a high probability of occurring; however the risk has to be taken into account.

The local moneymarkets, in pushing short-term interest rates down over the past two weeks, appear to have read far too much into recent weak employment, immigration and housing data. They are now only pricing in two further 0.25% OCR increases to 3.50%.

Retail sales and export performance data do not paint such a gloomy picture of the NZ economy.

It would be very surprising if the RBNZ stopped the removal of the 2009 monetary stimulus at 3.50%. They are on-track to increase the OCR to 4.50% over the next six to nine months, and this change is already priced-into the current NZD/USD exchange rate. It is doubtful whether the moneymarkets will persuade the RBNZ to stop the OCR increases at 3.25% or 3.50%.

The RBNZ will be very careful not to make another monetary policy mistake by holding conditions too loose for too long, following their error in holding monetary conditions too tight for too long in 2007 and thus causing the economic recession of 2008/2009.

It is difficult to see the Euro of Japanese Yen making any further gains against the USD on economic fundamental grounds. A return of the EUR/USD rate to $1.2500 and $1.2000 would pull the Kiwi back into the mid 0.6000’s. Such a movement appears to have a higher probability at this point than the NZD holding above 0.7000.   

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 * 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