Opinion: The outlook for the NZ dollar is getting more stable

By Roger J Kerr The NZ dollar is finally starting to display some stability against the US dollar that may be the feature of the foreign exchange market in 2009. After years of wild volatility, in the NZD exchange rate an outlook for a stable year might seem incongruent, but it is the more favoured scenario at this time. The speculative and trading interest in the Kiwi currency has certainly reduced in recent months, with most global hedged funds and investment banks seriously curtailing their minor currency trading activities and dealing with their own problems. The reduced international interest has also reduced market liquidity. The NZD/USD rate had a very brief flutter with 0.5400 on the back of a stronger AUD, but could not hold on to the gains and has since returned to trade quietly above around 0.5200 over this last week. The NZD foreign exchange market has already priced-in the potential for even further interest rate cuts following the RBNZ cut in the OCR to a record low of 3.5%. Forward market pricing has the OCR being lowered another 1.0% to 2.5%, although most would only expect a 0.5% cut to 3.0% at the Monetary Policy Statement on 12 March. It is unlikely that the NZD will be pushed lower on such announcements, as the current market rate of 0.5200 has already priced-in 2.5% interest rates in New Zealand and the NZ:US 90-day interest rate differential closing to 2.5%. Potentially the NZD could appreciate on what might be regarded as the final RBNZ reduction in interest rates. The FX market is always looking forward and they will more than likely view the cut in March as the last, therefore after that the next move in NZ interest rates will be upwards. The timing of the inevitable RBNZ unwinding of their current "super-loose" monetary policy setting will be the largest factor in driving the Kiwi's fortunes this year. It will need a return to more positive economic data. Right now with business confidence down and many sectors of the economy really struggling it is hard to see that happening in the short term. However, a more optimistic view of 2009 and 2010 (than what is currently been promulgated by the banks and RBNZ) could see interest rates and the NZD moving up again later in the year. The key forward-looking indicator for the economy, interest rates and the NZ dollar has to be our export commodity prices. Dairy prices are still falling as Fonterra play a high-stakes poker game with the supply of milk powder. However lamb, beef, fish, horticulture and forestry prices are holding well against the global recession. A stabilisation of dairy export prices should see confidence return in rural New Zealand and drive the export led-recovery. The RBNZ seem to be just extrapolating the deteriorating global recession as automatically meaning the NZ economy will go deeper into recession for longer in 2009. They seem to be forgetting that the big export industries drive the NZ economy, and the time to improvement on this front is arguably a lot closer than what the RBNZ realise.  The New Zealand economy's heavy reliance on food commodities is significantly different to Australia's metal and mining commodities. Australia's export volumes and prices of iron ore, coal and other minerals to north Asia is heavily dependent upon the Asian manufacturing of consumer goods (cars, appliances, electronics etc) and the sale to the US and Europe. That demand has slowed dramatically, thus Australia is much more intertwined with the global recession than what New Zealand is. We export food and international demand has not reduced to the same extent. What this means for the exchange rate is that the NZ economy is likely to recover back to positive GDP growth ahead of Australia. Our interest rates will need to be returned to normal "neutral" settings ahead of Australia, resulting in the NZD appreciating back upwards ahead of the AUD against the USD. There does not appear to be much further downside in the NZD/AUD cross-rate below 0.8000. Exporters in all currencies from New Zealand have been averaging-down the exchange rates in their currency hedge books and increasing long term hedging percentages. They must continue to do that to secure the advantage of the much lower Kiwi dollar value. ------------ *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