USD weakness off-sets local negative factors for the Kiwi dollar

By Roger J Kerr

A more permanent NZD value above the 0.7000 mark to the USD is emerging as the determining Australian dollar continues its strength in global FX markets as a result of higher commodity prices, a weaker USD value and investment markets returning to “risk-on” mode.

Perversely, improving economic data in the US is not causing the value of the USD currency to increase.

Improving US economic figures are seen as positive for hard commodity prices and the USD currency value moves inversely to commodity prices. Rising commodity prices are always positive for the Australian dollar and together with higher Australian interest rates and a Government now in place, international investors are again buying the buoyant Australian story.

The Kiwi dollar has been dragged to the top end of its trading range at 0.7300 and 0.7400 by the strong AUD, however somewhat reluctantly as local economic developments of late have not been positive for the NZD currency value. As a consequence, the NZD/AUD cross-rate has fallen away to new lows of 0.7650.

If the near neighbour AUD was not enjoying another bout of strength at this time for the reasons mentioned above, the Kiwi dollar would be trading below 0.7000 based on the local negative factors:-

- GDP growth for the June quarter released on 23 September was a real shocker for the financial markets and economic forecasters. The +0.2% increase was significantly below consensus forecasts of +0.8% and the official RBNZ forecast of +0.9%. Weaker than expected manufacturing data was one reason for the mis-forecasts, however retail was flat as expected and exports grew. The Kiwi dollar lost one cent on the news, however follow-through selling did not eventuate in offshore currency markets.

- A week earlier the RBNZ decided before the Canterbury earthquake that the weaker than anticipated economy this year meant that they could take longer to return the OCR interest rate to normal levels and remove the emergency monetary stimulus put in place 18 months ago. An environment of lower short-term interest rates for a longer period was seen as negative for the NZD, particularly vis-a-vis the Australian dollar. Again the NZD was sold down in the FX markets on the seemingly RBNZ about-face on New Zealand’s economic outlook. However, the weaker USD and stronger AUD in the markets since the Monetary Policy Statement on 16 September have more than off-set the lower interest rate negative for the Kiwi dollar.

The flip-flop from the RBNZ to suddenly change their 2011 GDP growth forecast from the previous +3.5% to +2.6% is quite disturbing.

It appears that because the RBNZ have horribly over-estimated GDP growth of 2010 (they had a forecast of +3.5%, whereas we are on-track for +2.0% increase due to very flat domestic spending), they are now running the risk of underestimating GDP growth in 2011. They also appear to be looking backwards at historical economic trends and changing the future forecasts accordingly. One cannot have a great deal of confidence of the RBNZ accurately forecasting the economy in 2011 when they were so far away from reality with their forecast of +0.9% for the June 2010 quarter, which finished three months ago! There is something disturbingly amiss with the RBNZ economic forecasting model when they were 0.7% wrong for a historical period where the majority of the components were already known.

The implications for interest rates and the NZD exchange rate from the RBNZ miss-reading the economy next year need to be understood. If local short-term interest rates are kept too low over the next six months and then the RBNZ suddenly realise in March/April that the 2011/2012 inflation risks have increased due to stronger than forecast economy, they will be forced to increase the OCR abruptly in large steps. That in turn will cause the NZD to appreciate on its own accord at that time. Part of the RBNZ mandate with managing inflation between 1% and 3% is that they must do so without causing undue interest rate and exchange rate volatility which restricts economic growth. The RBNZ are again running the risk of doing precisely this.

Despite the flat economic performance in 2010, the outlook for New Zealand’s growth in 2011 remains positive with record high agricultural commodity/export prices stimulating increased investment and production. Rural incomes will lift over the next 12 months and eventually the resultant increased spending will filter through to the cities.

The higher probability scenario for the NZD/USD exchange rate for the next 12 months remains at moderate weakness to the mid-0.6000’s over the next six months as the USD itself appreciates in global FX markets, thereafter gains back above 0.7000 in the second half of 2011 as NZ interest rates increase relative to US and Australian rates.

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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