Roger J Kerr says the rising risks related to the US fiscal cliff negotiations means the Kiwi dollar will not maintain rates above 0.8300 for very long. Your view?

 By Roger J Kerr

For the meantime it appears that the NZ dollar has broken out of the long-established 0.8100 to 0.8300 trading range to the topside.

The Kiwi dollar making gains of its own to 0.8325 following the Reserve Bank of New Zealand leaving the OCR unchanged at 2.50% last week, however the Governor’s assessment of the economy going forward proving to be much more positive and optimistic than the prior dovish expectations of the local moneymarkets and market economists.

The RBNZ’s updated prognosis on the economy being more in line with the reality that activity is moderately expanding, albeit patchy across industry sectors.

The more hawkish than expected outlook causing NZ dollar buying in the FX markets, lifting all the cross-rates and the TWI to above 74.50.

The painful irony of Governor Wheeler suggesting that the high NZD was hurting the export tradable sector, however his words driving the Kiwi dollar higher on the day, would not have been missed by most local exporters.

Also contributing to the demand of NZ dollars over recent weeks has been foreign buying of the Fonterra investment units on the NZX. More than half the IPO went into the hands of foreign investors and they need to buy NZ dollars to make the investments.

While $250 million is not a large amount in the context of the billions across the interbank FX markets every day, often it is the marginal buying or selling volumes on the edge that makes a difference to the price movements.

We have not as yet seen the expected profit-taking by investors in the NZ sharemarket after a year of strong capital gains. It was thought that the run-up to the US fiscal cliff deadline date of 1 January would cause increased equity market and currency market volatility due to the extreme uncertainty, however to date this has not eventuated.

The activities of foreign investors in the New Zealand sharemarket does have an influence on the exchange rate with portfolio capital inflows and outflows adding to Kiwi dollar buying and selling volumes. The correlation between the NZX50 Index and the NZD/USD rate (see chart below) is largely due to the currency tracking the Dow Jones Index as global investors switch between “risk-on” and “risk-off” modes.

A correction down in the NZ sharemarket over coming weeks may be one factor that returns the Kiwi dollar to 0.8100 and potentially lower.

New Zealand economic news continues to be something of a mixed bag as the year draws to a close. Weaker than expected retail sales and employment numbers three weeks ago for the September quarter pulled the Kiwi dollar lower.

However, since then the RBNZ OCR review, stronger construction figures (Christchurch re-build) and increasing business confidence results have been positive factors.

It was anticipated that a cut in the Australian official interest rates by the Reserve Bank of Australia would weaken the AUD and that would lower the NZD rate against the USD also. The RBA did cut by 0.25% to 3.0%, however that decision was fully priced-in in advance by the forex markets and the AUD did not go down after the announcement. Stronger than expected Aussie jobs figures last week counteracted earlier weaker retail sales, building approvals and GDP growth data. Anecdotal evidence still suggests that the Australian economy is struggling with the mining boom coming to an end and domestic industries under the pump from the high AUD value.

The Australian dollar has been the darling currency and investment destination for global investors since the GFC with its positive economic growth, AAA credit rating, safe banks and Chinese demand for its resources.

That dream run for the Aussie economy and their currency may now be coming to an end and thus international investors sitting on large currency gains may well be enticed to cash-up and pull out.

Those investors need somewhere else safe to park their money and up until now they have been reluctant to go into Euro’s or back into the USD.

With US economy continuing to improve and monetary stimulus measures now ended, the confidence about the USD itself should start to improve also.

The markets will be firmly focused on the US fiscal/budget deficit negotiations over coming weeks with time running down the uncertainty and risk levels should increase.

The net result of the time of year and market movements to date suggests the Kiwi dollar will not maintain rates above 0.8300 for very long.

It will requires a stronger USD globally and a weaker AUD in the region to get the Kiwi dollar below 0.8000 to deliver some relief for local exporters. Both seem more likely than the opposite occurring.

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 Roger J Kerr is a partner at PwC. 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