Soaring Kiwi likely to hit previous ceiling

By Roger J Kerr

The Kiwi dollar is flying high again as a combination of international and domestic developments encourages foreign exchange investors and traders alike that the New Zealand currency is preferred over others at this time.

The gains from lows of 0.7150 just three weeks ago when the Japanese earthquake caused sudden NZD selling as Yen/NZD speculative positions were unwound, have been dramatic. The NZD has shot up in a straight line due to the following buying forces all culminating together:

• The USD itself has weakened sharply against all currencies before and after the European interest rate increases last week.
• Higher oil and commodity prices have jettisoned the Australian dollar higher to a post-float (28 years) record of $1.0550 against the USD. The NZD continues to follow the AUD in currency markets.
• The NZ Government (through the NZ Debt Management Office) has taken the opportunity of strong overseas investor demand to issue more bonds in a smart “front-running“ debt issuance exercise of borrowing more than they need whilst the going is good. Sovereign wealth funds out of Asia in buying the NZ Government bonds have been buying Kiwi dollars without hedging their investments to other way. Our 10-year bond yields at 5.80% remain considerably higher than most other Government bond interest rates around the world.
• New Zealand’s export commodity prices continue to rise and rise. All NZ export commodity prices increased again in March and on this economic fundamental alone the higher NZD value is justified.

For the NZD/USD rates to continue on its upward trajectory to 0.8000 the above positive forces will need to remain in place and not fall away in intensity. On all counts that possibility seems remote. The NZD has appreciated to the high 0.7000’s on several occasions in recent years; however it has never been able to sustain the lofty heights for long.

The current gains are certainly not based on permanent capital inflows into New Zealand. The NZD buying is largely short-term speculative in nature, therefore the currency is prone to any negative news causing widespread NZD selling as trader profits are taken and long positions unwound.

Looking ahead, the type of negative news that could turn the NZD forex market sentiment and direction downwards would seem to revolve around the following:

• European interest rate increases have overshadowed the positive US economic news. The Euro gains against the USD from $1.4000 to $1.4500 appear to have fully priced that change in US: European interest rate differentials. There is no evidence of strong capital inflows into Europe from the US; therefore the Euro’s rise is exaggerated and very likely to reverse.
• The global currency markets appear to have ignored the most recent increase in Chinese interest rates as a negative for demand for commodities and thus there price increases. The China demand fuelled commodity price increases may have run their course and thus further AUD gains are less likely.
• There is one very plausible reason why the NZ Debt Management Office is borrowing more than they need early. They are managing against the risk of a NZ sovereign credit rating downgrade following the mid-May budget if Standard & Poor’s are not convinced that the Government’s economic policy initiatives will control future budget deficits and debt levels. Further Government financial contingencies surrounding South Canterbury Finance and AMI Insurance add to the probability of a credit rating downgrade. The Kiwi dollar could be expected to drop three to four cents on a downgrade. There is already a 30% chance of a downgrade with the current “negative outlook” status. The NZDMO issued $2.8 billion of bonds in March, well above the $1.2 billion programme.
• By the law of averages, the commodity price boom must run out of steam soon, adding to the reasons to be selling NZD’s at 0.7800 rather than buying.

A lower NZD/USD exchange rate forecast always required a stronger USD currency value on the international stage. That has not happened for a variety of reasons over recent weeks, however the US economy is fundamentally improving at a much faster rate than Europe and therefore the current USD weakness does not look sustainable.

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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