Roger J Kerr looks at what is in store for the NZD after the RBNZ rate hike pause and lower dairy prices, both of which now appear to be factored in to current pricing

 By Roger J Kerr

After depreciating sharply from 0.8800 to 0.8400 over the last month the NZ/USD exchange rate now appears to be in something of a hiatus period as the markets assess the next likely future impacts and direction.

Local determinants such as much lower dairy prices and the RBNZ on pause with further interest rate increases are known and factored into the current pricing.

It will require a fresh piece of negative news on the NZ economy to push the NZ dollar lower from its current level 0.8480.

In some respects the slight rebound off the lows of 0.8410 a week ago to 0.8480 is healthy for the still anticipated depreciation to 0.8000 as it clears out the previous short-sold speculative positions for a renewed wave of selling.

However, it requires a catalyst to trigger the new selling and right now it is hard to see what that local event or news will be.

The general election on 20 September does loom as a potential influencing factor, however to date the forex markets are not displaying any real reaction to the risks around the election and political outcomes.

Over coming months until the end of 2014 it is expected that major determinant of the Kiwi dollar’s direction against the USD will be how the US dollar itself moves in global currency markets.

All the signs continue to look favourable for further US dollar strength against all the major currencies, namely:

- US economic data over the last six months has been consistently stronger across consumer demand, manufacturing, business investment and employment. As a result the dual deficits of the internal Federal Government budget deficit and the external Balance of Payments deficit have reduced substantially, well ahead of all official forecasts.

- Rising inflationary pressures in the US economy are now occurring with the price decreases in the energy sector (the shale gas revolution) in 2013 no longer keeping the inflation rate down. For the Federal Reserve there appears to be elevated risks of the annual inflation rate going well above 2.00% than reversing back down again. Higher inflation in the US must ultimately mean higher short and long-term interest rates which are positive for the US dollar exchange rate value.

- In stark contrast to increasing inflation risks is the US, both Europe and Japan have the opposite problem of deflation. Very weak consumer demand and previous strong currency values are behind the lower domestic price trends. Interest rates have moved lower in Europe and the ECB are contemplating their next form of monetary stimulus and money printing. The Euro has already weakened to below $1.3400 against the USD and looks poised to fall a lot further. Global geo-political events over recent times have kept the Japanese Yen at the 101/102 level against the USD; however a rapid move to 105 appears much more likely than Yen strength from here.

Over-riding the aforementioned economic fundamental forces on the USD value will be how bond and equity markets react to the inevitable subtle but clear signal from Janet Yellen at the Federal Reserve as to how and when US short-term interest rates will need to increase. That signaling is expected sometime over the next two months.

The continued buying of US Treasury Bonds that has forced the yield down from 3% to 2.34% this year is completely at odds with rising inflation and short-term interest rates in the US in 2015.

The attractiveness of bonds to investors at this time does appear to be a vote away from the risks of equity markets over the period the Federal Reserve has to signal an ending of the anomaly of 0% interest rates.

There remains a view that lower interest rates in the rest of the world must make the 4% plus yields available in the NZ dollar very attractive to international currency investors/speculators.

Offsetting that view is the fact that the USD is expected to strengthen against all currencies and it is hard to see the NZD being an exception in such an environment.

Weaker than expected Australian economic data in the interest rate sensitive parts of their economy (retail and housing) over coming weeks will add to the building pressure on the RBA to consider further interest rate cuts from their current 2.5% OCR level.

The jobs lost from the downturn in new mining developments have not been replaced with new jobs in the other parts of the economy as the RBA were anticipating.

A lower AUD/USD exchange rate will take the NZD/USD rate with it in the current market environment. 

-----------------------------------------------------------

To subscribe to our daily Currency Rate Sheet email, enter your email address here.

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