Opinion: USD recovery will push the Kiwi down, not Bollard's warnings

By Roger J Kerr The NZ dollar exchange rate to the USD is starting to look like it wants to stubbornly remain above 0.6000. The Kiwi has traded in a relatively narrow range between 0.6250 and 0.6500 over recent weeks, reflecting more stability in USD exchange rate movements globally. The forex markets locally and internationally are (for the meantime!) completely ignoring the warnings and pleadings from Reserve Bank of New Zealand Governor, Alan Bollard that the appreciation of the NZD is unhelpful to the economy at this time and that foreign investors coming into the NZD had better be aware of the dangers of losing money if the Kiwi's trend reverses. It is certainly true that this premature rise in the NZD/USD exchange rate, if it persists for too long, will threaten the probability of an export-led recovery out of economic recession. The climb back to positive growth will be a hard slow grind, made even harder if exporters struggle to make profits due the recent NZD gains.

It is very apparent from various media reports that a number of major exporting companies, including dairy giant Fonterra, failed to hedge their currency risks forward to sufficient levels when the NZD/USD rate was in the low 0.5000's several months ago. The main reason for this failure to protect export receipts was that at the time leading economists in NZ were boldly predicting the NZD to go to 0.4000 to the USD and they convinced a few Boards of Directors to over-rule their own hedging policies and take a big punt. The cost of that weak financial governance is now plain to see. In examining and assigning probabilities to the various forces that will drive the NZD/USD exchange rate value over coming months, considerations has to given to the following factors: - The USD has stopped weakening against the Euro, Yen and AUD, however surprisingly still falling against the UK Pound. The unwinding of USD's purchased as part of flight of global investment funds to the safety and security of the USD six to nine months ago, appears to have run its course. The EUR/USD rate has stopped at $1.40, and should return to $1.25 when global FX markets realise that the US economy is going to come out of recession well ahead of Europe and the interest rate differential will move in favour of the USD. A recovery in the USD of this magnitude should pull the Kiwi back to 0.5700/0.5800. - The trend upwards in metal and mining commodity prices that has lifted to the Australian dollar to 0.8000 against the USD may have also run its course. Rumours are that the Chinese have been stockpiling commodities and have been the cause of the recent commodity price increases. Chinese demand for commodities is backed by internal infrastructure spend replacing previous growth in their manufacturing export industries. However, electricity production in China has always being highly correlated to their GDP growth. Plunging electricity generation this year in China suggests that they will not achieve the GDP growth that many in the West have been forecasting and hoping for. Expected renewed weakness in commodity prices over coming months due to a re-assessment of what is really going on in China will weaken the AUD, and the Kiwi is tracking the AUD very closely these days. - The interest rate differential between US and NZ 90-day rates has stabilised at 2.00% (2.80% in NZ and 0.80% in the US). The differential is highly correlated to the NZD/USD exchange rate and generally leads the currency movements. Currently the 2.00% differential points to a 0.5700 exchange rate. Either the NZD falls from 0.6400 or the interest rate differential lifts. It is hard to see the RBNZ increasing the OCR and 90 day rates for some time yet, therefore it appears more probable that the NZD/USD rate will pull back. - GDP growth figures for the March quarter are due this week. Consensus forecasts are for a contraction of -0.8% to -1.0%. An actual outcome weaker than this will force the NZD down, whereas a -0.5% result may cause some short-term NZD buying. - If international whole-milk powder prices continue to weaken over coming months and the NZD/USD exchange rate holds above 0.6000, Fonterra will be forced to drop their 2009/2010 milk-solids payout forecast to below $4.00 from the current $4.55. Such a change, if it was to happen, would be a very negative signal for the New Zealand economy as incomes in the largest export industry would be below cost levels. The economic consequences would be dire and force the NZD lower as international investors and currency traders re-rated the NZ economy downwards. Of all the above forces, what the USD does against the EUR will have the main impact on the NZD/USD exchange rate. The NZD gains since March have been pre-mature and damaging to the chances of economic recovery. There is not a lot the authorities here can do about USD weakness globally, however it has emphasised again to those with currency risks, that there is always two sides to every currency pair. "”"”"”"”"”- * 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