Opinion: Our commodity prices will fall when US interest rates rise

By Roger J Kerr The latest bout of NZ dollar strength to above 0.7100 appears as if it is going to be as short-lived as the previous pushes higher. It is somewhat surprising that the NZD has attracted short-term buyers in the face of the AUD being unable to hold onto its gains against the USD above 0.9300. The Kiwi dollar is still closely tracking the AUD on a daily basis in the absence of other over-riding forces on the currency. The AUD has failed to sustain gains above 0.9300 on several previous occasions over the last four months which indicates that global investors and traders believe that all the positive factors for the AUD are already fully-priced into the exchange rate at these levels. Therefore, do not expect the AUD to post further gains on the back of these forces. Those positive Aussie variables are higher interest rates, rising commodity prices and massive foreign investment capital flows into Australia. There is certainly nothing freshly positive coming out of the NZ economy to support the renewed NZD strength. The historically high export commodity prices are a real boost for the export industries, however the NZD/USD currency at 0.7000 and drought climatic conditions reducing production volumes take the gloss of the fantastic prices. The domestic economy remains very flat with retailers discounting to make sales and the housing market moribund awaiting tax changes in the budget next month. The local financial markets theme of recent months of our interest rates being “lower for longer in 2010” continues to hold. There has to be a question whether our dairy, fish, meat and log prices can continue to increase in the future as they are already at record highs. One major factor in global commodity pricing currently is that super low US interest rates (all commodities are traded and financed in USD’s) are aiding the high prices as there is virtually no financing cost to buy and hold physical commodities. The artificial and unusual situation for commodity markets will not last when it is signalled by the US Federal Reserve that US short-term interest rates will need to rise and they remove the current monetary stimulation. Just when that change will occur is the cause of much debate. If the US’s economic data continues to improve as it has done over recent months, that interest rate signal day may only be three to six months away. Expect global commodity prices, and thus the AUD to fall, when US interest rates are signalled to go up. The question for the NZ dollar forex market is how will they anticipate this change in advance and will this lead to earlier selling? USD:NZD interest rate differentials and the strength of the USD against the Euro to $1.3300 still point to a lower NZD/USD rate to the mid to low 0.6000’s. However, that movement cannot happen until the AUD and commodity prices decrease from current levels. In addition to the US interest rate trigger for that to happen, the markets will also need to see some fall-off in demand from China for imported commodities. The Chinese do not seem to be in any hurry to tighten their monetary policy further to prevent their inflation rate moving above 3.00%. Foreign exchange markets are anticipating a return to the 3% to 5% annual appreciation of the Yuan currency policy very soon. Such a change back to what they were doing prior to the GFC in 2008 would indeed be a further tightening of Chinese monetary policy as they seek cheaper imported goods. The Chinese will therefore resist any move up in USD denominated commodity prices going forward, as that would negate the inflation reducing pressures they desire. The current weakening trends of the UK Pound, Euro and Japanese Yen (now above 94.00 to the USD) have pushed all the NZD cross-rates higher. These movements have lifted the Trade Weighted Index to 66.75, certainly a level well above IMF and RBNZ expectations and forecasts. It has to be expected that the AUD and NZD will eventually react to the stronger USD on world currency markets and trade lower. It may also require falling global share markets on top of falling commodity market prices to shift these currencies lower. Global investors who are happy to buy the AUD and NZD currencies when risk assets are being put on the table are just as rapid to remove risk and become large sellers of the currencies when any minor economic or market shock comes along. Again, artificially super-low US short-term interest rates are creating a somewhat false confidence about corporate profitability this year. The global economic recovery of 2010 is still fragile and with considerable risk. The NZ economy is not recording the strong GDP growth normally associated with a recovery from recession. Growth forecasts of 3% and 4% for 2010 appear too optimistic. Our interest rates have stayed lower for longer as a result and ultimately this must tell on the currency and force it lower. —————- * 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