Roger J Kerr says the unwinding of speculative currency market positions is now threatening to send the Kiwi dollar lower still in the near term

By Roger J Kerr

The rapid decline in the NZ dollar value from 0.7390 a week ago to 0.7200 today is proof enough that the previous steep appreciation from 0.7180 on 21 March to 0.7390 was really a lot of speculative hot air that had no real substance behind it.

It was the view of this column at the time that there was no economic, investment or capital flow justification for the NZ dollar gains and therefore the speculators who pushed the Kiwi up would just as quickly take profits be selling it back down again.

The unwinding of those speculative currency market positions is now threatening to drive the NZD/USD rate below the key support level of 0.7180. A clear break below 0.7180 could well induce further technical/chart related selling and send the rate sharply lower again to 0.7100 and below.

It was very instructive for future rate movements last week that the Kiwi dollar failed to make further gains above 0.7390 when several factors occurred that would normally strengthen the currency further.

Dairy prices continued to increase in last week’s Global Dairy Trade auction, the US dollar weakened against the Pound and Euro and the Aussie dollar lifted to 0.7800 against the USD.

It has been reconfirmed by the FX markets yet again that there is no buying interest in the Kiwi above 0.7400. The long-established trading range for the NZD/USD exchange rate between 0.6800 and 0.7400 has been severely tested on the top side at 0.7400 on numerous occasions over the last 18 months and the Kiwi has failed each time to hold onto those gains.

Whilst the current New Zealand economic fundamentals of positive GDP growth and high export commodity prices remain supportive of a stable to stronger exchange rate value, the forex markets are much more forward looking in their price discovery and they are concluding that the New Zealand story is not as attractive as it once was.

There are a number of reasons as to why the forward economic and investment picture for New Zealand has swivelled from a very positive position/outlook to something nearer neutral over recent months:-

• Having climbed to 40-year highs over recent years, it is unlikely that our agricultural export commodity prices can increase any more. The greater probability is that they pull back as global food processors who buy our protein seek cheaper substitutes as our products become too expensive for them.
• The tit-for-tat trade wars between the US and China has prompted many economic forecasters to lower global growth estimates for 2108 and 2019 from previous very positive expectations of synchronised expansion in Europe, the US, Japan, China and emerging markets. The NZ dollar and Aussie dollar are regarded as a “growth/commodity” currencies and the outlook is certainly not as positive as it was a few months back. The trade tensions have driven iron ore prices sharply lower and therefore it is of no surprise that the AUD/USD rate has nose-dived from 0.8100 in late January to below 0.7700 today.
• The economic policy direction of the new Labour Coalition government in New Zealand has now become more apparent to the FX markets and they do not like what they see. Last week’s banning of new offshore oil and gas exploration may be defended by some as being a long way in the future, however the signal it sends to all prospective foreign investors into the New Zealand economy is not positive (i.e. be wary of New Zealand as the government can change the rules on you overnight). The failure of business confidence levels to rebound after the plunge last October/November is testament to the fact that business firms remain very uncertain around labour market conditions/laws and worry about what may be coming next from this “transformational” government.
• At 2.88% per annum, our 10-year Government Bond yields are now eight basis points below the 2.96% market yields of US 10-year Treasury Bonds. There is no yield enhancement available in New Zealand anymore for international investors and thus more reasons for them to sell out of NZ bonds and sell the NZ as they exit.

Whilst the reasons for being more negative on the NZ dollar outlook in the short-to medium term are well justified, looking ahead beyond 12 months a return to the mid-0.70’s against the USD cannot be ruled out.

NZ interest rates will eventually be lifted in late 2019 and the US dollar itself may well be weighed down by their growing internal budget deficits through 2019 and 2020.

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.