Opinion: Do the forex markets know best?

By Roger J Kerr Two weeks ago there were some minor possibilities that domestic announcements and events here in New Zealand could have knocked the Kiwi dollar off its upward track. The OCR review statement form the RBNZ, a potential Fonterra milksolids forecast downgrade and rising unemployment were potential negative factors that could have broken the Kiwi's nexus with the Dow Jones Index, the AUD and the CRB Commodities index. It has transpired that none of these factors have eventuated to punctuate the Kiwi's impressive gains.

The FX markets clearly know something more positive about the NZ economy and NZ future interest rates than what Alan Bollard and I can fathom out. Or do they? The Kiwi gains to above 0.6700 are in my view not a positive commentary on NZ's economic prospects or performance. We have merely followed the AUD up as global equity and commodity markets continue their relief rallies following the plunges down that went too far last year. The real question for the NZD/USD exchange rate from here is whether these global sharemarket and commodity rallies can continue, or have they over-shot the reality of still weak global demand and profits over the next 12 months? If they have over-shot on the upside, the USD itself should be able to improve as commodities slip back. For the first time in many months the USD gained on world forex markets on Friday night in response to better than expected US economic data. I am still confident that international fund managers and currency traders will start to favour the USD over the EUR, GBP and JPY over coming months as the US economy comes out of recession ahead of Europe and Japan, and associated with that US interest rates increase earlier than Europe and the UK. A change of sentiment back in favour of the USD is long overdue and for this reason I see a Kiwi back to the low 0.6000's rather than pushing on to 0.7000. The EUR/USD rate has been sitting around $1.4000 for far too long now to support a view that the USD has to weaken substantially further. If the justification for a weaker USD was there, the markets would have sold it to $.15000 already. They have not done so. Therefore the risk/reward equation is continuing to sway back in favour of a USD recovery. The Government and Alan Bollard are acutely aware the damage the current extreme volatility in the NZD/USD exchange rate is doing to the confidence of most of the export sector. Not a lot they can do about it if the world tags us along with the rising hard commodity prices and the AUD. However the consequences of this premature NZD currency appreciation is that the anticipated export-led economic recovery does not materialise at all and sooner or later the offshore players in the Kiwi will wake up to this fact. I do not agree with the business groups that are calling for FX market intervention or moving away from a free-floating currency to address the problem. However one change that does have to occur is a major re-think on the monetary policy framework, as the massive swings in interest rates in recent years have largely caused the rise, fall and rise of the Kiwi dollar. That currency volatility has gutted USD exporters and caused far too much damage to the productive sector. "”"”"”"”"”- * 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