Opinion: Breaking the link of the NZD to the AUD

By Roger J Kerr The Kiwi dollar has bounced back up again from lows of 0.6820 on two occasions over the past two weeks. On both occasions the short-term NZD buying was unrelated to any positive economic of financial news coming out of the local market. As with the price movements late in 2009 when two and three cent swings over the course of 48 hours trading on the international FX markets were the norm, the Kiwi dollar has continued the daily volatility this year with unpredictable and sudden jerky movements both up and down. What has become evident is that global currency speculators who use to play in the NZ dollar market are no longer so prominent and international investor interest is much reduced. The Australian dollar with higher interest rates and a much more vibrant economy looks far more attractive. Unfortunately for local exporters hoping for further NZD depreciation as the USD strengthens globally, positive news out of Australia that drives the AUD upwards, also spills over into short-term NZD buying. Stronger employment figures in Australia last week contrasted starkly against weaker NZ employment numbers for the December quarter. The Australian figures lifted the AUD and were a major factor in lifting the Kiwi off from 0.6820 and back up again. The Kiwi now appears to have major resistance from trading above 0.7000, with speculators and investors not prepared to build new net long NZD positions above 0.7000. The NZD/AUD cross-rate has remained relatively stable between 0.7850 and 0.8000 throughout the last three of four months, indicating just how closely the NZD/USD rate is tracking the AUD/USD exchange rate on a daily basis. Whilst the AUD/USD rate remains the dominant force over the NZD/USD direction in the short-term , other medium-term NZD currency drivers such as commodity prices, interest rate differentials, relative economic performance and the direction of the USD against the Euro, all suggest a continuation of the NZD downtrend against the USD to 0.6500 and below.

"¢ Global mining and metal prices recovered dramatically last year after the plunge they experienced in late 2008. Whether the 2009 price gains have built in too much expectation in terms of 2010 world economic growth remains to be seen. Unwinding of monetary and fiscal stimulus by several countries in 2010 is not positive for commodity prices as interest rates and the USD currency move back upwards. Supply constraints may hold some particular commodity prices up, however if global demand wanes the speculators and fund managers will be sellers of commodities. New Zealand agriculture commodity prices have made excellent gains in recent months. But there has to be some doubt as to whether these elevated prices are sustainable over the remainder of 2010. "¢ Over the next six months The Reserve Bank of New Zealand will be leaving OCR interest rates stable at 2.50%, whereas the Reserve Bank of Australia will be increasing there OCR rates by at least another 1.00% to 4.75%. As a result the AUD is favoured over the NZD with international investors pulling funds out of New Zealand and re-investing in the higher yielding Australian market. It appears inevitable that the NZD/AUD cross-rate will move lower yet to 0.7700/0.7600 before some recovery towards the end of the year when NZ interest rates are finally increased. "¢ Recent employment, housing and retail sales data on the NZ economy has been universally weaker than expected. The economic recovery is confirmed as being hard and slow in 2010. The RBNZ need not be in any hurry to start lifting interest rates. Our very poor relative economic performance vis-a-vis Australia is plain to see. The New Zealand economy will markedly under-perform Australia this year, and so will our currency over the next six months. "¢ The USD has recorded major gains from $1.50 to $1.36 against the Euro over recent months as investor confidence in Europe decreases. Even though Greece has been rescued with an EU loan, there still exists real worries about other European economies and the exposure of the large European banks to some of these economies. The USD is on track to make further gains as Federal Reserve Chairman Ben Bernanke starts to signal the phasing out of monetary stimulus, which in the end will mean increases in US interest rates well ahead in timing of Euro interest rates. The NZD/USD is closely correlated to the EUR/USD exchange rate and a continuation of USD gains to $1.30 would have the Kiwi well below 0.6800. In 2009 the USD weakened as commodity prices increased and the world worried about the US's twin deficits. In 2010 those concerns are long forgotten and reversed as investors fret about financial and economic risk in Europe. The USD doomsayers have been proved wrong and further USD appreciation appears very likely. "”"”"”"”"”- * Roger J Kerr runs Asia Pacific Risk Management. 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