Roger J Kerr says it will be interesting to see what the Reserve Bank says next week about the New Zealand dollar, which is much higher than our central bank was forecasting

By Roger J Kerr

The New Zealand dollar continues to outperform the major currencies against the US dollar with the NZD/USD exchange rate at 0.7290 today not too different to where it was trading prior to the election of Donald Trump as US President last November.

In stark contrast, the Yen, Pound, Euro and Aussie dollar are all weaker against the USD over that time period.

It is not that the Kiwi dollar is being specifically singled out by global currency traders and speculators as a “buy”, indeed its attractiveness as a carry-trade currency has diminished with reductions in NZ interest rates and increases in US interest rates. What has occurred in the FX markets is that there is no real reason to sell the Kiwi dollar, compared to string of economic and geo-political developments that have weakened the other currencies against the resurgent USD.  The net result is rising cross-rates to the Yen, Pound, Euro and Aussie dollar.

The NZ Trade Weighted Index (“TWI”) reflecting those higher cross-rates has surged 3.5% higher to 79.70 from 77.00 at the start of January. The New Zealand economic story continues to be very positive with strong GDP growth and elevated business and consumer confidence levels contributing to the reasons not to sell the NZ dollar.  

It will be interesting to see what the RBNZ say about the much stronger TWI at their upcoming 9th February Monetary Policy Statement. The RBNZ are currently building in a 76.4 reducing to 75.1 TWI assumption into their 2017 inflation forecast. They will need to revise their inflation forecast lower with imported consumer goods much cheaper at a 79.7 TWI starting point.

RBNZ Governor Graeme Wheeler had hoped that successive OCR interest rate cuts in 2016 and a stronger US dollar as the Federal Reserve raise interest rates would pull the TWI down in 2017 to lift inflation. The opposite is currently occurring, so Graeme cannot ignore the currency question a week on Thursday.

The real economic impact of a higher TWI is through reduced export prices, production, profits, investment and jobs. Already the higher NZD/GBP and NZD/EUR cross-rate have hit the sheepmeat trade with New Zealand’s overall exports for 2016 at $48.4 billion lower than both 2015 and 2014.

The big dairy and meat export industry sectors do not hedge the currency risk as far forward as other exporters.  Our manufacturing and food exporters into Australia do not make much in the way of profit at a 0.9650 NZD/AUD cross-rate. They will be pulling back production/exports if they cannot get compensating price increases in the Aussie market.

Should whole milk powder dairy prices pull back further from US$3,280/MT at the next GDT auction on Tuesday 7th February the current bright NZ economic outlook might start to dim a touch. Add on a housing market that has seen its peak and struggling exporters into Australia and the positive NZ economic story starts to have some chinks in its armour.

The NZD/AUD cross-rate has returned to its recent highs of 0.9650 with the NZD appreciating from below 0.7200 to 0.7290 against the USD, whereas the AUD/USD rate has remained stable at 0.7550.

The two historically reliable lead-indicators for the NZD/AUD cross-rate, interest rate differentials and commodity price differentials, both point to a substantially lower NZD/AUD from here. However, the recent divergence away from the previous close correlations has been happening for quite a few months now. Something will inevitably give that pushes the Kiwi dollar down on its own accord.

The problem is that it is difficult to see what that negative catalyst could be at this point.

Roger J Kerr contracts to PwC in the treasury advisory area. 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