Opinion: Defying economic reality

By Roger J Kerr Very few local foreign exchange market dealers, participants, commentators or analysts are able to adequately and succinctly explain why the NZ dollar continues to go up when the outlook for the NZ economy is going to other way. Kiwi dollar gains continue to 0.6900 continue to confound the pundits, however it is difficult to see the currency reversing to a downwards trend unless some major and unexpected negative event hits the markets. For the meantime the buyers of the Kiwi are happy to maintain long positions in the belief that the NZD will follow the AUD higher. So far this currency strategy has proved fruitful.

The AUD continues to be in favour around the globe as a commodity and growth currency that is preferred over the USD. Aiding the AUD is the outlook for Australian interest rates with the moneymarkets now pricing-in increases of 2.00% in short-term interest rates over the next 12 months. The Reserve Bank of Australia is on course to become the first central bank to lift interest rates following the emergency cuts in official interest rates across the global last year. The AUD gains against the USD are certainly justified in terms of an economy that hardly went into recession, rising hard commodity prices and now rising interest rates. However the question is whether the Aussie forex markets have already fully priced these positive AUD variables and further AUD gains against the USD above 0.8400 may be very hard earned indeed. In contrast, the NZ economy remains in recession and will struggle to get up to positive GDP growth next year now that the dramatic appreciation of the NZD over the last few months has severely damaged export profits and confidence. New Zealand's agriculture export prices have not increased and RBNZ Governor Alan Bollard is now clearly going to keep NZ short-term interest rates "lower for longer". There are no positives for the Kiwi on its own, the gains are purely the NZD following the AUD against the USD. At some point the offshore traders and investors long the NZ dollar will realise that the New Zealand economy is significantly under-performing the Australian neighbours and they will reverse their currency positions. Just when that realisation will dawn is difficult to estimate, but it seems likely to occur before the end of the year. When the reversal does come, as it inevitably will, the NZD/USD rate will plunge rapidly as once again too many sellers attempt to exit the narrow door (low market liquidity) at once. Both the Government and Reserve Bank are extremely worried about the adverse economic impact of the rapid climb in the NZD. A strongly appreciating currency is the very last thing the NZ economy needed as is seeks to recover from a recession largely caused by the tight monetary policy of the RBNZ in 2006 and 2007. The RBNZ now has nowhere to go with official interest rates at 2.5%. They know the currency has to be lower for the economy to recover, but all they can do is warn to Kiwi buyers of the dangers of their actions. So far, the RBNZ jawboning has had absolutely no impact in the market. The global players are happy to lump the NZD together with the AUD as it suits them to do so and they know no better. There is still a possibility that one of the credit rating agencies may downgrade New Zealand's sovereign rating as they observe that the higher NZD value makes it far less likely that New Zealand can reduce its Current A/c deficit and return to positive GDP growth in 2010. A continuation of a weak economy as the expected export-led recovery fails to materialise, means that the Government's tax revenues will be less than forecast, the deficits and borrowing requirements even larger. These are all factors that point to a credit rating downgrade for New Zealand. A downgrade cannot be ruled out at all in terms of a negative event that breaks the Kiwi's nexus to the AUD, the Dow Jones Index and commodity prices. The rally upwards in equity, credit and commodity markets over recent months does not disguise the fact that the NZ economy is now going to struggle to recover as the previous low currency stimulus has disappeared. If international FX markets were going to sell the USD substantially lower due to the plunge in the US economy last year and the resultant massive indebtedness to the rest of the world, they would have already done so by now. The fact is that they haven't and from here US interest rates will be increasing well ahead of Europe's. The view continues to be held that the USD will recover from $1.40 to $1.30 against the Euro over coming months. These anticipated movements in the USD suggest a lower NZD/USD rate from above 0.68 to the low 0.60's. "”"”"”"”"”- * 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