Opinion: The dangerous game of picking a top for the Kiwi dollar

My initial view six to eight weeks ago was that the NZD upsurge since March would peak out at the 0.6600/0.6700 region. A weaker USD, stronger AUD and stronger commodity prices has put paid to that call! So with somewhat more hesitancy this "courageous and/or silly" currency forecaster is now picking that 0.7200/0.7300 will be the turning point in the Kiwi. And we may have already seen that peak. Just proves that there is only the quick and the dead when it comes to short-term FX rate forecasting. The next few weeks will prove or disprove this view very conclusively. Over the last two weeks a number of economic and financial market price action developments provide some credence to the view that the upward momentum in the Kiwi is running out of steam and the risk of a sizeable reversal in direction grows:- - Global commodity prices are no longer recording the gains they were a month or two ago. China may have completed its stock re-building of commodity raw materials at the lower prices they moved on earlier this year. The commodity short-sold position holders from 2008 have now brought back and squared their positions. There are more question marks being asked in the commodities/fuels markets as to the level and sustainability of global economic demand in a more normalised monetary conditions that will be returned to in the US and Australia (at least) in 2010. The Baltic Dry Index for sea freight rates is often a good lead indicator for oil and commodity prices. It has turned down over the last two months as lower global trade volumes and additional shipping capacity combine together. The Kiwi follows the AUD and the AUD follows the CRB commodity price index. The CRB Index is now hovering around 250 and has run out of puff in terms upward momentum. - The gains in global sharemarkets over the last six months have played a prominent role in driving the Kiwi higher as the reduction in risk aversion by investment funds has attracted international money to alternative and riskier asset classes like the Kiwi dollar. The upcoming earnings results season in the US will need to deliver to the high profit expectations already built into share prices. There is certainly room for disappointment as economic data in the US is now painting a much more mixed picture and weak labour markets weight on consumer spending. Big global fund managers have been very keen for this sharemarket rally to sustain itself as they seek to post strongly positive investment performance numbers in 2009 to compensate off the massive negative numbers their investing clients suffered in 2008. It is all about keeping the client's money to maintain the fee income! The growing question in equity markets is how much this rally upwards in prices is driven by money being invested in shares because the alternative returns in cash and fixed interest are too low. In other words, cheap money and liquidity sloshing around is behind the share buying more so than positive views about company earnings growth in a stronger economic environment. Again, the rally will not be sustainable as and when monetary conditions normalise. - The two aforementioned forces have dominated the NZD/USD direction in recent months over and above the normally dominant interest rate differentials and USD currency movement drivers. My view is that it is inevitable that there will be a return to interest rate differentials (thus Kiwi depreciation) when the commodity and sharemarket gains buckle in the face of economic reality. What we do know about the Kiwi dollar is that, when it does reverse direction and go down, it normally plummets in a mad-cap rush to get out before its value falls any further. Overseas players all rush the exit door at once and the NZD/USD market liquidity is just too small to cope with the volume of selling. Examine below the six occassions of Kiwi plunges in excess of 10 cents over the last six years. As sure as eggs it will happen again, however from what level and exactly when is the tricky part! Also what we know is that the catalyst this next time will not be Mr Bollard and/or Mr English talking it down. "”"”"”"”"”- * 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