Although the immediate threats are priced in to the value of the NZD, markets are forgetting that our currency does get safe-haven benefits during debt crises in other regions

By James Riley

Most local economic forecasters, in particular bank economists, have been predicting of late that the Kiwi dollar will continue to depreciate this year.

Forecasts for the NZD/USD exchange rate to decline to the 0.6500 to 0.6700 area have been common.

US dollar exporters managing their FX risks based on these predictions would have not been hedging forward against the risk of a NZ dollar appreciation. In fact, the majority of the banks have consistently published forecasts over the last two years of the NZD/USD rate falling in the mid 0.6000’s.

They have been consistently wrong!

The NZD/USD exchange rate has oscillated between 0.6800 and 0.7500 since June 2016 and any USD exporter who has adopted the hedging strategy of lifting hedge percentages when the Kiwi dips below 0.7000 has been consistently rewarded with valuable protection for when the Kiwi subsequently appreciates. The documented NZD/USD currency view of this column over recent weeks has been that the Kiwi dollar sell-off into the 0.6800/0.6900 region would run out of steam and that USD exporters should be actively hedging against the risk of a reversal back upwards.

The Kiwi dollar rebounded to above 0.7000 last week as currency market positioning caused buying demand; that is, the Kiwi had been over-sold and those speculators holding short-sold NZD positions were busy buying the currency back to unwind and take profits. There was no particular positive news for the New Zealand dollar last week, however it could be argued that the risks around the mycoplasma bovis bacteria issue and Italian politics subsided as the respective Government authorities took decisive action.

Looking ahead, there are numerous variables and factors that are undergoing change at this point in time that will impact on future NZD/USD exchange rate movements:-

• Business confidence levels in New Zealand have not really improved since their plunge lower last October when the new Labour Coalition came to power. There still appears to be a high degree of uncertainty around future labour market conditions and compressed business profit margins, therefore business investment is stalled. The “own activity” index for business firms continues to indicate GDP growth nearer to 2.00% for the year ahead, well below the 3.00% growth forecasts of the Government, RBNZ and most private sector economic forecasters. As our GDP growth under- performs that of Australia, expect the NZD/AUD cross-rate to remain in the lower 0.9000 to 0.9300 trading range.
• New Zealand’s export commodity price increases appear to have peaked-out after reaching 40-year highs in the December quarter. The Terms of Trade Index (export and import prices) decreased 1.9% in the March quarter and further declines are forecast over coming quarters as dairy, meat and forestry prices ease off and import prices increase due to the recent oil price movements. Historically, there has been a strong correlation between the Terms of Trade Index (ToT) and the NZ exchange rate Trade Weighted Index (TWI). However, over recent quarters the Kiwi dollar TWI has not matched the gains in the ToT. Therefore, further falls in the ToT through 2018 and 2019 will not necessarily cause a major shift lower in the TWI (currently at 73.27).
• US import tariff flip-flops by President Donald Trump continue at an alarming daily rate, which is unsettling for global free trade that the NZ economy is highly dependent upon. Trump mistakenly sees the US trade deficit with China as a negative for the US economy and he wants to address it with import tariffs (appealing to blue-collar worker’s votes). All he is doing is disrupting US manufacturing supply chain sources and upsetting the Canadians, Brazilians, Mexicans, Europeans and Koreans who supply steel and aluminium into the US (not the Chinese!).

The three aforementioned factors are not altogether positive for the NZ economy and thus the Kiwi dollar. However, they are all known by the forex markets already and provided these factors do not deteriorate further they should not push the Kiwi lower.

On the other side, there was a hint through the recent financial and investment market sell-off due to the mess that is Italian politics and potential negative consequences for the EU that the Kiwi dollar was viewed as a “safe-haven” currency, far removed from the EUR and USD.

It should be recalled that the Kiwi dollar appreciated on safe-haven flows in 2011 and 2012 at the height of the Greek and European debt crisis.

In addition, foreign exchange markets always price future conditions up to 12 months ahead of time. In that respect you cannot get away from the fact that in 12 months’ time the US will be coming to an end of their interest rate increases and New Zealand will just be starting to lift rates – a clear NZ dollar positive.