Look back and learn: why the NZ dollar will stay in a tight range

By Roger J Kerr

While the NZD/USD exchange rate remains very volatile in the markets day-to-day, bouncing around one and two cent trading ranges, the overall pattern over the last 12 months has been one of settling into an overall much tighter longer-term range.

Over the past year the Kiwi has remained broadly between 0.6700 and 0.7300, a narrow six cent trading range which is quite the opposite of the currency’s behaviour in recent years. Over the previous four years (2006, 2007, 2008, and 2009) the average high to low trading range for each year was an astronomical 20 cents.

There are a number of very good reasons why the NZD/USD exchange rate may be returning to a much less volatile period, similar to the period from 1989 to 1996 when the annual trading range (high to low) was between four and eight cents.

In the early 1990’s New Zealand experienced a very bad economic recession with export commodity and local property prices depressed. Interest rates were lower than what they had been and there was no international investor interest in New Zealand as the economic story was not that pretty.

Through the mid 1990’s the economy recovered and the eventual higher interest rates led to much increased international trader and investor interest and activity.

Remember Julian Robertson and his Tiger hedge fund buying all the Kiwi dollars they could get their hand on? The Asian financial crisis in 1999 and the very strong USD over that period returned the Kiwi to lows of 0.4500 again.

The reason for that short currency history lesson is that history often repeats.

The New Zealand economy in again emerging from a recession, however this time the export commodity prices are high. Given all the circumstances the NZD/USD looks to be entering a similar period to the mid-1990’s when the rate of change was slower and the cycles were longer and slower than what we have experienced in recent years.

The underlying reasons why the NZD/USD may be returning to narrower annual trading range are summarised as follows:-

- New Zealand interest rates are now much closer to those of the rest of the world, global investor interest with carry-trades and such like are much reduced.

- New Zealand’s economic fundamentals are not overly hot or cold. While private sector debt levels are high when Government debt is growing again, we are a lot better off than most other countries on the economic health check-list.

- The USD currency value against the major currencies is not an extreme under-valued or over-valued position (except perhaps the Japanese Yen), therefore volatility from a major shift in value in the USD is unlikely over coming years.

- The global investment/banking crisis of 2008/2009 has significantly reduced speculative and trading interest in exotic currencies such as the NZ dollar.

On the basis that the US economy does better than Europe over the next few years (thus earlier increases in interest rates), the USD should hold its value and improve in international currency markets. Then, a NZD/USD trading range over the coming 12 months is more likely to be from the mid-0.6000’s to the mid-0.7000’s i.e. not too different to what we have witnessed over the past 12 months.

Surprise “no OCR increase” would send the Kiwi dollar lower

On the local financial market front, the moneymarkets are now only pricing-in two further 0.25% OCR increases over the next 12 months.

The interest rate markets have moved their position substantially over the last two months with weaker retail, housing and manufacturing data now prompting local bank economists to predict a much earlier pause in the removal of the monetary stimulus.

The RBNZ report their prognosis on the economy and their strategy with monetary policy settings on 16 September with their comprehensive quarterly Monetary Policy Statement. The RBNZ could we well advised not to listen to the doomsayers on the economy who are calling for a continuation of emergency monetary stimulus measures, the RBNZ’s job with managing inflation between the required 1% to 3% band is to look forward 12 to 18 months.

Looking back at historical economic data is not what the RBNZ should be persuaded on at this juncture.

While a “no OCR increase” in 16 September might be what the bank economist and moneymarkets are now calling for, it would be a major and sudden policy U-turn for the Governor and he is not prone to doing that.

The reaction by the international foreign exchange markets to a RBNZ “no increase” on 16 September will be to sell the Kiwi dollar down on its own account, as it will be seen around the world as something going wrong with the NZ economy.

The reality is that the NZ economy is posed to grow strongly in 2011 with export commodity prices at record highs and terms of trade at 30-year highs. The side-ways trending domestic economic sectors are not the whole economy, although many commentators seem to think so.

In summary, the outlook for the Kiwi dollar is drifting into the 0.6500 to 0.7000 trading range over coming months and then more likely to be appreciating back above 0.7000 in the second half of 2011 as the economy grows at a 3.5% - 4.00% clip.

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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