'The last time farmers earned over $134,000 a year was 2001/2003 when the Kiwi dollar was 0.4500 to the USD.'

 By Roger J Kerr

The NZ dollar has butted its head up against the resistance ceiling at 0.8400 on several occasions over recent weeks, without attracting the conviction from new buyers to send it convincingly higher.

International equity and currency markets have settled somewhat in February after the strong gains at the start of the year due to positive Chinese and US economic data during January.

Volatility measures (i.e. VIX Index) have reduced and this has aided the continuation of the NZD strength.

The daily movements of the NZD/USD exchange rate are not presently being influenced by local NZ economic data. However, the year has commenced with further evidence that the NZ economy is tracking along at a more robust pace than what most economic forecasters have been expecting.

Last week there was confirmation of farmer incomes being up 17% on the previous year to average NZ$134,000; residential property sales activity and prices were up, as were retail sales for the December quarter. GDP growth for the December quarter could well be another positive 0.6%, on top of the 0.8% increase in the September quarter, when it is released on 22 March.

On a relative basis compared to other countries the NZ economy is currently expanding at an annual GDP growth clip of +3% - and that is before GDP measurement differences that understate our GDP compared to Australia – according to the Reserve Bank of NZ gurus.

It is little wonder that the NZD is at a strong point when GDP growth performances are compared.

We are doing very well with the strong underlying economic fundamentals of still historically high agricultural commodity prices. The last time our farmers earned over NZ$134,000 in a year was in 2001/2003 when the Kiwi dollar was 0.4500 to the USD.

Despite all the positives for the Kiwi dollar, the feeling is that they are all priced-in to the exchange rate already and the following negative factors that could push the NZD down are lurking in the markets:-

• While official Chinese economic growth data has been strong to date, the anecdotal evidence mounts that activity has slowed in recent months. The PBOC has again relaxed bank reserve ratio requirements, indicating that maybe the officials are preparing for a more rapid slowdown than previously anticipated. Market analysts see annual Chinese GDP growth slowing from 8.9% to 8.2% this quarter. The NZD was shoved up in January on the back of stronger Chinese data being positive for the AUD and commodity prices. That market consequence would reverse abruptly if Chinese economic data comes out weaker than expected over coming weeks.
• The USD itself has started to make gains of its own on the back of the more positive US economic figures. The USD currency Index has climbed back to 79.25 and should add to those gains as the US economy out-performs both Japan and Europe this year. Japan eased monetary policy considerably last week; further Yen weakness to well above 80.00 to the USD has to be expected.
• The NZD gains to 0.8400 are over-extended when compared to the close historical correlations to the EUR/USD exchange rate, the Dow Jones Index and Wholemilk Powder prices (see chart below). The thin and less liquid FX markets over the New Year period exaggerating the gains well in excess of these major drivers.
• While the Greeks and the EU edge towards agreement on the second bail-out and the risk of a Lehman-type financial melt-down in Europe has abated, any new setbacks on resolving the European sovereign debt crisis will be met with sell-offs in global equity markets and thus a weaker NZ as a consequence. Risk appetite from investors remains fickle and frenzied, thus “risk-off” periods will continue to see NZD selling. 

Holding the Kiwi dollar up near 0.8400 has been a stronger Australian dollar, buoyed by stronger employment growth numbers and the decision by the RBA not to cut their official interest rates two weeks ago. The AUD/USD rate has encountered strong resistance previously at the 1.0800 level, with their manufacturing (export as well as import substitution) and retail sectors really suffering from such a high currency value. While the mining/resources states of Queensland and WA complain about labour shortages, manufacturing plants in NSW and Victoria are announcing redundancies and lay-offs. One wonders for just how much longer their currency can reflect only part of their economy.

In the meantime, as global investors/traders in the Kiwi dollar see the NZ economy as one large dairy farm, they might wish to reflect on the current wide divergence between the NZD/USD exchange rate and wholemilk powder prices. Based on historical correlations, the Kiwi at 0.8400 does not appear sustainable.

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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