By Roger J Kerr
As expected, the NZD could not hang onto its gains above 0.7000 made two weeks ago and has recoiled back to the 0.6800’s.
It was not mini-shocks out of Europe that has caused the NZD to reverse back down. Indeed, the Euro has strengthened against the USD to $1.2500 over this last week as financial and economic matters settle in Europe.
The reasons for the latest bout of NZD selling have been more related to global investors taking risk off the table again.
Investors appear to have become spooked over recent weeks by general global economic developments, not one factor in particular.
Previous periods of pronounced weakness in international equity and commodity markets have been related to single events like the Lehman bank collapse in late 2008 or the Greek sovereign debt fiasco a few months ago.
The current selling just seems to be a growing nervousness about the sustainability of the recovery out of recession for the global economy.
Many are concluding that the stock/inventory rebuilding process assisted by super low interest rates, that was behind sharemarket gains last year and early 2010, has now run its course and the underlying consumer demand is not following through. Latest Purchasing Manager’s Indices (PMI) in the major economies (including China) have reversed backwards of late, indicating that the 2009 boost from stock re-building has evaporated.
Investors are worried that still high unemployment and high debt levels is preventing any increase in consumer spending that every economy needs to improve GDP growth levels.
The risk of a world “double-dip” recession is growing and the sharemarkets and commodity markets are reflecting this risk.
The Dow Jones Index is now well below 10,000 and even though PE ratios in most equity markets are well below historical averages, investors are still reluctant to buy as a double-dip recession would pull back corporate profits even further.
Outside lower sharemarket indices and a lower CRB commodity index, two market movements provide the evidence of just how nervous and cautious international investors have become in recent weeks.
The US Government 10-year Treasury Bonds have reduced in yield to below 3.00% (from 3.80%) under the weight of investor’s money wanting the safe-haven and security of the safest bonds in the market.
The Japanese Yen has strengthened from 92.00 to 87.50 against the USD as Japanese investment houses bring funds home (buy Yen) as they too become concerned about international markets. On economic fundamentals and performance the Yen should be closer to 110.00, however forex values and markets can and do become seriously out of whack for long periods of time.
While a serious global double-dip recession is not a high probability at this point, the New Zealand economy would be directly and adversely affected by such a second downturn. Our commodity prices would struggle to hold onto the current high levels and the expected rural-led spending increases would fail to materialise. Lower hard and soft commodity prices would be negative for both the AUD and NZD values against the USD.
The Australian FX markets were somewhat perplexed and confused as to the implications for them on the political dawn raid that saw PM Kevin Rudd rolled and replaced by Julia Gillard. The subsequent Gillard deal with the mining industry to revise the super-tax policy provided some short-term support for the Australian dollar. However, more negative global economic developments have returned the AUD/USD rate to 0.8400 from highs of 0.8800.
The Reserve Bank of Australia will leave their official interest rates unchanged today and their employment growth may have levelled off in June after strong increases the previous month.
The EUR, GBP and JPY cross-rates to the NZD have pulled back to the lowest levels seen for several months as the NZD/USD rate falls without any corresponding weakness in these currencies against the USD. Both US and Chinese economic data has been weaker of late, causing the USD to weaken, but also lowering commodity prices which is always negative for the NZD.
In a reversal of what was seen a month ago when all these cross-rate increased, the double-whammy impact of a weaker USD and NZD has sent the crosses sharply down.
Looking ahead, in the short-term lower business confidence levels in the quarterly NZIER survey and potentially lower prices in the fortnightly Fonterra on-line milkpowder auction could weigh the NZD/USD rate down.
In the medium-term, if the prospect of a global double-dip recession grows the NZD will be sent lower by lower commodity prices and the RBNZ pausing on their path to return interest rates to normal levels.
However, the more likely scenario over coming months is the world economy muddling through and the NZD/USD exchange rate spending its time in the 0.6600 to 0.7000 trading range.
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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
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