A relief bounce following the Budget comes as hedge fund book squaring stops the slide in the NZD and other selling forces run out of steam at US$0.6850

By James Riley

Over the last 18 months, the NZD/USD exchange rate has bounced back up again on three separate occasions from the major support line of 0.6850.

The FX markets were unprepared to sell the Kiwi down below 0.6850 in three separate NZD sell-offs in December 2016, May 2017 and October/November 2017.

We are back here again and early signs are that the selling forces that have depreciated the Kiwi from 0.7400 in mid-April are running out of steam on this occasion as well. The speculators who pushed the Kiwi up to 0.7400 have been busy unwinding their positions over recent weeks, thus selling the Kiwi to do so and fueling the downward momentum.

However, that book-squaring by the hedge funds appears to be ending and therefore, yet again, the Kiwi looks set to bounce back up again from the 0.6850 support region.

The other factors that have pulled the NZD/USD rate down from 0.7400 to 0.6850 over recent weeks also appear to have exhausted themselves and are not expected to continue with the same intensity over coming weeks/months, namely:-

• The NZD/USD rate largely follows the AUD/USD exchange rate. The Aussie dollar has plummeted six cents from 0.8100 to 0.7500 against the USD since late January. Up until recently, the NZD/USD rate had only decreased by two or three cents and was seriously lagging the AUD depreciation. However, the Kiwi invariably catches up to the AUD. By moving in to the 0.6800’s the Kiwi has now also depreciated six cents from its highs. The independent catch-up NZD selling has seen the NZD/AUD cross-rate drop from 0.9500 to 0.9200.
• Lower metal and mining commodity prices due to the trade war tensions between the US and China lowered the AUD to 0.7500 against the USD through March and April. However, iron ore prices have stabilised over recent weeks as the Chinese start to see the sense of allowing more American export goods into their market. Underlying global industrial demand for hard commodities that Australia produces appears more robust this year than previous years, therefore do not expect continuing AUD weakness.
• US interest rate increase and weaker European economic data in the March quarter were behind a USD turnaround from $1.2500 to $1.1800 against the Euro. That USD recovery may have also run its course as latest US inflation figures point to only two more Federal Reserve rate hikes this year, not three as some were anticipating.
• Initial local financial market reaction to the 10 May RBNZ Monetary Policy Statement was to sell the Kiwi dollar, as the inference was that Governor Orr was more dovish than expected on the OCR outlook. Sharp increases in fuel prices of late have reminded the punters that inflation is not entirely dead and future OCR cuts are much less likely than increases.

The 0.6850 bottom of the Kiwi’s trading range is expected to hold firm over the coming period.

The Labour Coalition Government’s budget last week caused a very brief flurry upwards in the NZD/USD rate to 0.6930, as there was relief in some quarters that they had maintained fiscal surpluses and not spent all the excess cash!

However, there has been very little media or market comment that the projected budget surpluses over coming years are largely based on some very heroic assumptions by The Treasury that GDP growth will average well above 3% and the tax revenues will keep on flooding in as they have done in recent years. Projected fiscal surpluses can disappear very quickly if economic growth slows, tax revenue reduces, but the increased spending commitments are locked-in.

Fiscal policy assumptions are always at risk to how the economy performs.

There was nothing in Finance Minister Grant Robertson’s first budget that was aspirational, motivational or inspirational to the business sector to lift business investment and output. The budget was a re-distribution exercise as most anticipated it would be.

Business confidence is expected to remain at the current lower levels through the winter months, pointing to slower GDP growth below 2.00%. The building/construction sector has maxed-out of resources; therefore, this growth impulse will reduce this year.