Weak business confidence in New Zealand's public policy makers could trigger a currency downgrade if Thursday's GDP data shows an evaporating growth track

By James Riley

After pushing up to a high of 0.7050 earlier last week, the NZD/USD exchange rate has succumbed to another wave of AUD selling and has retreated a cent lower to 0.6950.

The Kiwi dollar tracks the Aussie dollar very closely in the FX markets on a day-to-day basis unless there are separate and independent forces at work on the individual currencies against the USD that cause a divergence. Only then does the NZD/AUD cross-rate undergo change.

The AUD has been out of favour in the minds of international investors for a number of months now, the main cause for the negative sentiment being the fact that both Australian short-term and long-term interest rates have fallen well below those of the US as US interest rates are increased by their Federal Reserve central bank. The AUD/USD exchange rate has depreciated 8% to 0.7450 from the highs of 0.8100 in January. It would appear that those global investors and speculators who wanted to reduce AUD exposures have now already done so, therefore at 0.7450 the AUD could be a tad oversold against the USD.

The AUD has been vulnerable to any negative news on the Chinese economy and the latest escalations in tit-for-tat retaliatory trade tariffs between the US and China will not be positive for the AUD.

On the flipside, the Aussie dollar is highly correlated against its key export mining commodities such as iron ore, copper and gold. Iron ore prices are once again bouncing up from their support area of US$65 per tonne, in addition to that, copper and aluminium prices continue to increase. The AUD/USD at 0.7450 is well below the level these key commodity prices suggest it should be.

The NZD/AUD cross-rate has moved sharply higher to 0.9330 as the Kiwi has out-performed the AUD since the Kiwi rebounded upwards form its strong support level of 0.6850 a couple of week ago. At 0.9330, the NZD/AUD appears to be over-stretched on the topside and a pullback to below 0.9200 in the short-term would not surprise.

The catalyst for NZD selling against the AUD could well come this Thursday (21 June) when the New Zealand GDP growth numbers for the March quarter are released.

Market expectations are for a 0.7% increase for the quarter, however several lead indicators point to a much lower number around +0.3%. The Kiwi dollar will be sold on its own account if this important economic growth measure is weaker than most expect.

The Labour Coalition government has not really done anything positive in recent months to garner the confidence and support of the business community, who remain uncertain about the potential changes to the employment market, taxation policies and immigration policies. While business investment remains in a holding pattern due to these uncertainties it is difficult to see the economy expanding at the 3.5%/4.0% clip we achieved in 2016 and 2017. A poor GDP growth number this week will contrast rather starkly against the +1.0% expansion the Australian economy recorded in the March quarter. Another reason for the NZD/AUD cross-rate to depreciate back to the 0.9100/0.9200 region.

The EUR/USD exchange rate has remained in the $1.1500 to $1.2000 trading range as previously expected. The Euro was sold on the ECB statement last week that they were ending their money printing (bond buying) later this year, the negative factor for the Euro being that the guidance on the timing of the first interest rate increase in 2019 was pushed further back, well beyond what the financial markets were anticipating. The EUR/USD rate moved in the $1.1500’s, however the Trump induced trade war with China can hardly be seen as positive for the US economy or the USD currency value. Certainly, US farmers will not be happy with Chinese tariffs on their exports and most US manufacturers will be unhappy with the US import tariffs on their steel and aluminium purchases from Canada, Brazil, Korea, Japan and Europe. Weaker than expected economic data in the UK has pulled the Pound exchange rate lower to $1.3280 against the USD.

If the NZD/USD rate does dip a further cent to 0.6850 on a weak GDP outcome, it would be a forward hedging opportunity for EUR and GBP exporters as over the medium term both these cross-rates are forecast to track higher.

Emerging market currencies such as Turkish Lire and Indonesian Rupiah have been under sharp downward pressure over recent weeks as international investors downsize their exposures to these equity markets.

A stack of funds moved into emerging market equities when US interest rates were very low a few years back. However, that benign environment has changed dramatically today with increasing US interest rates. Many emerging market economies have US dollar denominated debt and the local cost of servicing that debt skyrockets when the exchange rate comes under attack by disinvestment.

It would be incorrect to categorise the New Zealand dollar into the same bucket as these emerging market currencies. Our financial institutions and economic policy framework are more robust and the Kiwi dollar is much more closely linked with our major export commodity, whole milk powder. Dairy prices remain very stable at profitable levels and there is nothing in the outlook to suggest any softening in those prices.