Can the Kiwi dollar sustain its giddy-heights?

By Roger J Kerr

It is becoming harder and harder to sustain a view that the NZD/USD exchange rate will correct back to the mid 0.7000’s when the rest of the world seems to be in love with our economy and our currency.

The reality of global FX markets currently is that there are very few currencies that stand out as having a positive economic growth outlook, assured interest rate increases and no public debt problems.

The NZ dollar just looks so good relative to the other major currencies (except the Swiss Franc) as the USD, the EUR, and the JPY currently all have question marks in respect to economic performance, interest rates and debt.

We look good right now because most of the others are so rubbish.

However, from 0.8350, does this mean that the future path of the Kiwi is just onward and upward to 0.9000 as some bank economists are boldly telling our clients?

All one can say to that is that the very same bank economists were forecasting 0.4000 for the NZD/USD rate in March 2009 when the spot rate was at 0.5000. It did the opposite.

In examining the main drivers of the NZD/USD exchange rate, the murky crystal ball today tells me the following:-

- Even though the local short-term interest rate market has not yet been able to fully reflect the certainty of future rate increases (reinsurance funds and a lack of mortgage fixing artificially holding rates low), the FX market may have already priced-in interest rates increasing from 2.50% to 4.50% early next year. Therefore further Kiwi buying at that time now seems less likely.

- The Europeans have increased their interest rates and got the Greeks to make economic changes, however the Euro has not strengthened on that so-called good news. Italian and Portuguese bonds are now blowing out. It is only a matter of time before ongoing Euroland debt problems drag the EUR/USD rate below $1.4000. The Kiwi has de-linked from the EUR/USD for the meantime (the NZD/EUR cross-rate at almost 0.5900 confirms this NZD out-performance), however a 5% drop in the EUR/USD rate to $1.3500 in the short-term would still reduce the Kiwi by four cents to below 0.8000.

- All is not well in Australian economy, despite their notoriously volatile jobs figures recording a strong increase last week. Australian manufacturing companies are struggling with the high AUD hurting export profitability and cheap imports hurting local manufacturers. The Australian economy has to be vulnerable to metal and mining commodity prices correcting further downwards as this is their only growth sector. Global investors and currency speculators are more likely to be sellers of AUD at these levels as China tightens monetary policy further and increases in hard commodity prices seem much less likely.

- International investors and currency markets have been reluctant to buy the USD itself whilst the US Government debt ceiling issue remains unresolved. It is unthinkable that the Democrats and Republicans will not compromise on the budget savings and approve a debt ceiling increase well before the 2 August deadline date. When they do that, perhaps within the next week, a negative shroud is removed from hanging over the USD currency value.

- One has to be very suspicious as to why Statistics NZ delayed the release of the March quarter GDP numbers last week only a day before the due date. My reading of the situation was that the preliminary GDP growth number was so far away from consensus forecasts of a +0.4% increase that they needed more time to check the component parts thereof. An outcome this Thursday well below +0.4% will be negative for the Kiwi dollar.

In summary, Chinese and Australian economic news will be relatively more important than local economic developments for the Kiwi dollar over coming weeks. The news on the sovereign debt front is likely to favour the USD ahead of the Euro.

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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