Roger J Kerr says markets don't expect NZD-AUD parity is sustainable because income differentials can't support it and the AUD is due for a 'long overdue' correction higher

By Roger J Kerr

Last week the considered view was that the positive and negative forces being applied to the NZD/USD exchange rate were evenly balanced and a continuation in the 0.7200 to 0.7600 trading range was by far the most probable scenario going forward.

Recent financial news and events confirm that viewpoint with sharply lower wholemilk powder prices at the GDT auction a negative influence.

However, a lower than expected US jobs figure for March was decidedly negative outcome for the US dollar and the Kiwi dollar moved upwards to 0.7600 accordingly.

While the NZD/USD has flirted with the top end of the 0.7200 to 0.7600 trading range of late, it still appears that the speculative traders in the Kiwi dollar market are very reluctant to be aggressive buyers above 0.7600.

Outside US dollar direction on the global FX markets over coming weeks, the next major determinant of NZD directions will be the CPI inflation numbers released on 20 April.

A negative CPI figure is forecast for the March quarter which will lower the annual inflation rate to zero.

The calls for the RBNZ to lower interest rates will be loud and prolonged as a result.

With the strong economy and a housing bubble the RBNZ will not be cutting interest rates anytime soon, however the headlines calling for that action may be sufficient to drive the speculators out of the Kiwi dollar.

The spectacular gains of the Kiwi dollar against the A$ from below 0.9500 to 0.9950 on the cross-rate over the last few weeks will also be tempting for long NZ dollar position holders to reverse engines and become Kiwi dollar sellers to realise their profits into cash.

The Reserve Bank of Australia is likely to cut interest rates again this week, however that news is already fully priced into the currency markets and further AUD depreciation against the USD is not expected.

Tumbling iron ore prices have hurt the AUD over recent weeks, however further AUD selling below 0.7500/0.7600 against the USD does not seem likely as all the bad news is already priced into the market.

The RBA will be careful not to give the impression that this interest rate cut will not necessarily be their last this year, however market players may well see it this way if Aussie economic data starts to improve.

The AUD/USD has been highly correlated historically to copper prices and the recent divergence with copper prices moving higher and the AUD lower does not look sustainable. A recovery in the AUD is becoming long overdue; however the markets need a positive catalyst to commence buying the AUD again.

Very few currency market commentators see the 0.9950 level of the NZD/AUD cross-rate being sustainable in the medium to long term.

The flirtation with parity of NZ$1 = A$1 may be very brief according to the majority view.

If New Zealand wage and salary levels were increasing dramatically to reduce the 20% gap in incomes between Australia and New Zealand the equivalent exchange rate values to the USD may be justifiable. However, there is no evidence of the income gap closing; therefore on a cost comparison basis it is difficult to see the NZ dollar maintaining its recent gains to the Australian dollar.

When and how the expected downward correction to the low 0.9000’s plays out is unknown at this point, however the two-year interest rate differentials between to two currencies still points to a 0.9200 cross-rate, not parity.

The interest rate differential lead-indicator has been a very accurate predictor of the NZD/AUD rate for many years.

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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