Tumbling commodity prices and falling Aussie dollar shatter NZD stability

By Roger J Kerr

The mood and sentiment towards the New Zealand dollar in the foreign exchange rate markets has changed dramatically over recent weeks. The markets have moved rapidly from the previous positive support for “commodity” and “growth” currencies such as the NZD and AUD, to negativity and selling by international investors/traders as they reduce their risk levels. The Kiwi dollar has depreciated sharply from 0.7200 to 0.6700 over the past two weeks, largely following the sudden turnaround and aggressive selling of the Aussie dollar.

The sea-change in confidence and exchange rate direction has been prompted by four offshore developments:-

- Disinvestment from Euro-denominated investment assets following Germany’s decision to ban short-selling of their listed shares and bonds. The Germans made their decision without consultation or notification with their fellow European Union partners and this indicated a further breakdown in Europe’s unity following the Greek sovereign debt crisis and subsequent EU/IMF bail-out. International investors have lost confidence in European economic policy makers and are voting with their feet. The weakness in the Euro exchange rate against the USD to the low $1.2000’s reflects the shift in global investment asset allocations and a certain degree of panic hedging.

- More question marks about China’s economic growth sustainability, further tightening of Chinese monetary policy and their own concerns about property market bubbles have combined to damage confidence in the Asian growth currencies i.e. the AUD and NZD.

- The oil price and hard commodity prices have reversed downwards as these markets start to worry about threats to Chinese-led global growth and demand. The CRB Index has tumbled from 280 to 257. Global investors always buy and sell the Australian dollar on the direction of commodity prices and the AUD/USD exchange rate remains highly correlated to the CRB Index. Also as stated in previous columns, global commodity prices would not continue to increase and would fall back once there was more certainty around the timing of US short-term interest rate increases. Recent US economic data and official comments suggest that the day is drawing nearer when US monetary policy settings are progressively changed from super-loose to a more neutral position.

- The continuation of negative economic developments in Europe that have once again spooked share markets around the world about economic recovery and growth prospects in 2010, have probably caused the Reserve Bank of Australia to pause with their increase in interest rates. With commodity prices falling and Aussie interest rates potentially rising no further, the reasons and rationale for holding long AUD position in the FX markets have been blown away.

The AUD was always vulnerable to a massive correction down, if and when the international investment mood changed. Currency speculators and international investment funds were extremely over-weight in AUD assets prior to this latest sell-off in global shares. The reversal of those forex market positions has been swift and severe on the Aussie dollar. Over the past three weeks the AUD has been thumped down from 0.9300 to 0.8300. The level of foreign investor participation in the NZD dollar market with long positions has reduced significantly over the past 12 months with NZ interest rates below those of Australia. As a consequence, the NZ dollar has not suffered the same selling volumes experienced in Australia, therefore the NZD/AUD cross-rate has reversed upwards from 0.7700 to above 0.8000.

How far down can the NZD/USD move on these latest Australian and international market/economic developments?

At least another five cents to 0.6200 seems likely as the less liquid NZD FX market catches up to the new AUD and EUR levels to the USD.

The interest rate differential to Australia still suggests a NZD/AUD cross-rate closer to 0.7600 than 0.8000. From the low 0.6000’s the NZD should find support on its own account with increasing interest rates from here, high agriculture commodity prices and stronger GDP growth in the second half of 2010 and into 2011.

Last week’s Government budget had no direct impact on the currency value, however the tax changes are positive for future economic growth and investment. At the end of the day exchange rates reflect relative economic performance between nations. Once the NZ domestic economy expands in 2011, feeding off the export growth improved by a lower NZD value, the picture is not one of poor economic performance and a depreciating currency.  

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* 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