Roger J Kerr says dairy prices remain the wildcard in the performance of the NZ currency against its US counterpart

By Roger J Kerr

The rollercoaster they call the Kiwi dollar has enhanced its reputation over recent weeks as the NZD/USD rate has swung wildly between 0.6900 and 0.7050.

The local FX market has both bought and sold the Kiwi in reaction to developing news.

The sell-off over the last month to 0.6900 was due to plummeting dairy commodity prices, however that variable has weakened in intensity as most would see whole milk powder prices now stabilising in the US$2,700/MT area. Certainly the futures prices are indicating this.

In a classic “buy the rumour, sell the fact” response the US dollar itself has weakened following the widely anticipated 0.25% increase in US official short-term interest rates by the Federal Reserve last week.

The sentiment and expectation in the global financial markets around the timing of US interest rate increase this year changed dramatically over a very short space of time. In January and February the US interest rate markets were only pricing-in a 30% chance of a Fed hike in March. A continuation of stronger US economic data and up beat speeches from Federal Reserve Governors rapidly changed that pricing to a 100% probability by early March, which Janet Yellen duly delivered.

The US dollar posted strong gains against the Euro through November to January from $1.1200 to $1.0500 in anticipation of increasing US interest rates. However, those speculative long US dollar positions were unwound when the actual increase or “fact” occurred last week. As a result, the US dollar was sold from $1.0600 to $1.0740, sending the NZD/USD rate sharply higher from 0.6900 to 0.7040 on Thursday 16th March.

The gains by the NZ dollar due to a weaker US dollar proved to be very short-lived last week when our GDP growth figures were released for the December quarter later in the morning of 16th March.

The prior consensus forecasts were for a 0.7% expansion of the economy following the very strong September quarter’s numbers.

There was immediate disappointment and Kiwi dollar selling when the growth in the final quarter for 2016 come out at a much lower than expected +0.4%. The Kiwi dollar reversed engines from the US dollar related gains to be sold back down to 0.6975.

A closer examination of the GDP growth data away from the newswires headlines revealed that the weaker outcome was entirely due to adverse climatic conditions late last year reducing primary and manufacturing production volumes. In the dairy industry milk production volumes have since recovered somewhat with warmer and wet climatic conditions through the first three months of 2017. Therefore not too much should be read into the lower GDP growth result. Outside of primary production, the rest of the economy (particularly tourism and construction sectors) continues along at a very robust pace.

The net result after all these short-term currency market gyrations is the NZD/USD exchange rate is trading within expected ranges at this time.

A strong NZ economy does not allow sustained NZ dollar selling to occur, on the other hand the US dollar itself should remain strong as the US increases interest rates and other major economies are a very long way from doing that.

As previously commented on in earlier columns, the two aforementioned forces cancel each other out and thus leave the Kiwi dollar stable in the 0.7000 to 0.7200 region.

The wildcard that can always cause the NZD/USD to move away from its expected course is movements in dairy commodity prices. Over recent weeks the correction back down in international whole milk powder prices has removed some gloss off the Kiwi dollar, however it is not terminal and dairy prices are expected to stabilise over coming months. The NZD/USD direction over coming months is therefore more likely to be governed by how the neighbouring Aussie dollar moves against the USD.

The Australian dollar has once again appreciated against the USD to 0.7700, however this has been a major ceiling or barrier for the Aussie for almost 12 months now and further gains above this level do not seem likely.

The Australian dollar is potentially vulnerable to a reasonable sell-off if their metal/mining commodity prices start to correct downwards. The hard commodity prices have increased substantially since late 2016 on the back of expected increased infrastructure investment in the US (one of the major Trump pledges).

As time passes and there is still no substantive policy detail from the Trump administration in this area, the commodity market players will become frustrated and disappointed at the delays. A major pull back in metal/mining commodity prices over coming weeks/months as the long position holders take profits and become sellers, would be negative for the Aussie dollar and would push the NZD/AUD cross-rate back up again from current rates around 0.9100.

At a NZD/USD exchange rate of 0.7000 and the overall TWI Index at 76.20 the New Zealand dollar is near to its fair equilibrium value in the author’s view. In the medium to longer term, US driven trade protectionist trends from the Trump administration would be negative for the NZ economy and thus the Kiwi dollar. Eventually, increases in both dairy prices and NZ interest rates will be Kiwi dollar positive. A continuation in and around 0.7000 looks the more likely scenario over coming months.

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Daily exchange rates

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Roger J Kerr contracts to PwC in the treasury advisory area. 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