By Roger J Kerr
Last week the Reserve Bank of New Zealand expressed an opinion that any sustained period of a stronger NZ dollar currency value would adversely affect New Zealand’s economic growth prospects in 2010 and 2011.
The RBNZ opined that the stronger NZD currency was inconsistent with the softening in New Zealand’s economic outlook and the moderation now being seen in our export commodity prices.
They are stating the obvious, however that does not help export growth and investment that is always impinged by a NZD/USD exchange rate staying stubbornly above the 0.7000 level.
Global currency markets and the traders/speculators who dominate short-term movements completely ignored the RBNZ comments and continued to buy and sell the NZD based on AUD, EUR and US sharemarket movements.
To be fair, the NZD did weaken following the RBNZ comments that accompanied the OCR increase to 3.00%.
The age old Kiwi dollar dichotomy of the short-term forces against the longer-term economic realities is showing up again.
The RBNZ have revised down their 2010 GDP growth forecasts as the domestic market remains flat and the expected increase in business investment is not materialising.
The local moneymarkets are now pricing in a slower rate of increase for the short-term interest rates, a change that would normally be negative for the NZ dollar.
However, the FX markets are not currently pricing the NZD value off interest rate differentials or NZ economic fortunes. The day-to-day currency movements continue to be dominated by global economic and market events. As has been stated previously, it will take an unexpected shock that is negative for New Zealand on its own, to break the nexus the NZD/USD exchange rate has to the global market drivers.
Right now it would seem that only a surprise such as an OCR “hold” (as opposed to further increases) or a collapse in Fonterra’s milk powder prices would attract the attention to break the currently dominating global linkages.
Another Fonterra milk powder auction tomorrow may provide some Kiwi dollar weakness as it appears that the Chinese have their milk powder inventory levels back to normal and are now less worried about future supplies.
A major reason behind the NZD gains to above 0.7000 is USD weakness against all the major currencies over recent weeks.
Weaker US economic data and no further sovereign/economic shocks out of Europe have driven the EUR upwards to $1.3060 against the USD. How long the Euro can maintain these gains is debatable.
While recent US economic data has printed on the weaker side, in the medium-term the US economy is expected to out-perform Europe by a wide margin.
Therefore, US interest rates will be increasing in 2011 well ahead of any increase in European interest rates.
It is difficult to see the Euro continuing to appreciate above $1.3000 against the USD and a return to $1.2000 is a higher probability. That anticipated reversal of the USD/EUR exchange rate should pull the NZD/USD rate back below 0.7000.
It is increasingly difficult to reconcile the gains of the Dow Jones Index and better than expected US company earnings increases with the weaker US economic data.
The improved company earnings results seem to be related to the inventory re-building that took place in the first part of 2010 than more recent wider US economic trends. There are still challenges ahead for the US economy; however the recent spate of weaker economic data is not expected to continue. Latest Chicago PMI figures (intentions of purchasing managers in manufacturing businesses) suggest improved economic numbers coming out of the US over coming months.
Global commodity price movements remain a key driver of the AUD exchange rate against the USD (thus the NZD/USD rate); therefore it is not surprising that the AUD has appreciated to above 0.9000 with the CRB world commodities index increasing from 260 to 274.
Yet again the gains in energy and hard commodity prices at this time are hard to comprehend against the weaker US economic data and the Chinese PMI reducing again.
Unless there are specific supply-side constraints, muted global demand does not suggest a continuation of increasing commodity prices.
Any sharp correction downwards in the CRB index would drive the AUD and NZD lower. After spectacular gains over the past 12 months New Zealand’s own export commodity prices (meat, dairy, forestry etc) now seem more likely to correct downwards over the coming period. Local exporters and farmers need a lower NZD/USD exchange rate to accompany that price movement to maintain profitability and incomes.
The Australian dollar is not yet showing any signs of reaction to what will be a very close-run Federal Election in three weeks time. The NZD/AUD cross-rate has pulled back to just above 0.8000 as the AUD out-performs the NZD against the USD. A sustained fall below 0.8000 is not expected as the interest rate differential between the two currencies increases with NZ lifting short-term official interest rates and Australia having completed their increases some time ago.
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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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