Opinion: Too much appreciation for the kiwi

By Roger J Kerr The NZ dollar continues to record stellar gains in the global forex markets, despite becoming even further irreconcilable with New Zealand's weak economic fundamentals at this time. The NZD/USD exchange rate traded as high as 0.6875 last week, but has retreated rapidly from the highs as the US sharemarket takes a breather after 14 days of straight gains. The close NZD linkage to the US sharemarket and global commodity prices has pushed the currency higher from 0.6500 to 0.6800 over the last fortnight. It is a debatable question as to whether the higher equity and commodity prices are reflective of improved economic figures or whether merely short position holders from earlier in the year are being forced to buy back their sold positions. Either way, the positive confidence from investors and traders has projected the Kiwi dollar higher as it is lumped together with the AUD and CAD commodity currencies. Any correction down in commodity and sharemarkets over the coming period will be positive for the USD and negative for the NZD. The dramatic and largely unexpected 36% appreciation of the NZ dollar over the last few months will have severe adverse consequences for the New Zealand economy.

The-economy desperately requires an export-led recovery out of recession. That recovery to positive GDP growth is now looking highly unlikely as NZ exporters in USD are not profitable and will not expand or invest at current exchange rates above 0.6500. The speed and volatility of the currency movements have exporters running scared, not the environment to stimulate an economic recovery. The Reserve Bank and Government are issuing the warnings that a housing/consumer spending-led economic recovery will not be sustainable and end in tears like all the previous boom/bust cycles. For the NZ economy to expand there is a fundamental need for export growth. The latest NZ dollar gains have stymied that opportunity. The international investors, traders and speculators who have been buying the NZD do not seem to be aware of the weak economic performance and the likelihood that the currency appreciation will prevent any recovery out of recession. We have been pulled up with the AUD as mining and metal commodity prices rise on inventory rebuilding in Asia. The offshore buyers of the Kiwi do not seem concerned that New Zealand's soft agricultural commodities have not increased, thus exporter's returns are sharply lower. At some point this difference between Australia and New Zealand will be realised. The Reserve Bank of Australia has firmly indicated that its next move in interest rates will be upwards and the markets are pricing this to occur before the end of this year. By contrast the RBNZ is signalling that NZ interest rates will remain lower for longer as the higher NZD halts the economic recovery. The day of reckoning will come for the Kiwi dollar, however it is hard to predict just when the linkage to the Dow Jones Index, the commodity prices and the AUD will be broken. It will require a catalyst of events to break the nexus and force the long NZD position holders to reverse their books. The only possible negative development that could arise to knock the Kiwi dollar of its perch is bad news on the NZ sovereign credit rating front. Fitch has put New Zealand on a negative outlook, concerned about the Current Account deficit. Apparently it was a very close call back in May by Standard & Poors to retain New Zealand's AA+ international rating. The Government's budget just did enough to prevent a ratings downgrade. Last week, the third credit rating agency, Moody's expressed some concerns about the New Zealand banks and their lending exposures to a weak economy. Maybe a shock credit rating downgrade will be the event that scares away the poorly informed foreign investors from holding the NZ dollar. The US economy is set to recovery to positive GDP growth well ahead of Europe. Federal Reserve boss Ben Bernanke will not make the same mistake that Alan Greenspan made in 2002/2003 when he kept US interest rates too low for too long after emergency monetary policy action. Increasing US interest rates later this year and into 2010, well ahead of the Europeans, should see the USD recovering from $1.4000 to the Euro to $1.3000. Such a move would pull the Kiwi back to the low 0.600's. The NZ dollar has made gains on all the cross-rates to the AUD, EUR, JPY and GBP, lifting the TWI Index to over 63. Monetary conditions under the old MCI Index scale are now back at neutral (zero) due the currency appreciation, a very long way from the -1000 the RBNZ desires for loose conditions to assist the economy back to recovery. The RBNZ can attempt to talk to the currency lower, however they realise that any further cuts in the OCR to below 2.5% will not necessarily work to lower the NZ dollar as the banks continue to pay much higher interest rates for deposits and borrowing to fund their loan books. The RBNZ has lost its influence and power with OCR adjustments, it seems only time will correct the NZ dollar down value to closer to its fair equilibrium value of somewhere near 0.6000. "”"”"”"”"”- * 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