Roger J Kerr says if early next month the NZD/USD exchange rate is around 0.6500 and whole milk powder prices near to US$2,200/MT then the RBNZ will be justified in holding off from any further OCR interest rate reductions

By Roger J Kerr

Despite lower whole milk powder dairy prices and a stronger US dollar currency value on global FX markets over recent weeks, the NZD/USD rate has stabilised and range traded (as expected) in the 0.6500/0.6600 region.

Local banks have been unanimously forecasting a lower NZD/USD exchange rate to below 0.6000 for many months now due to lower dairy prices, a stronger USD and a weaker NZ economy. Well, the first two forces have occurred and the NZD/USD remains in the mid 0.6000’s.

On the weaker economy scenario, their prediction has been misguided as it appears that the NZ economy will record stronger GDP growth in the second half of 2015 compared to the first half of the year. Recent retail sales and other economic data points to the economy expanding by over +0.6% in the September quarter and arguably higher in the December quarter as business and consumer confidence bounce back.

The US dollar itself has posted gains from $1.1000 to $1.0600 against the Euro over recent weeks in the lead up to the Federal Reserve’s 0.25% interest rate increase on 17 December. The current mood in international currency markets is that the Federal Reserve will not increase interest rates further in 2016 at the clip earlier expected; therefore the USD gains against all currencies have come to a halt.

It is instructive that Emerging Market currencies that have been under so much downward pressure due to low mining commodity prices (e.g. Brazil and South Africa) have stabilised against the USD of late despite commodity prices edging lower in the markets. The global investment capital that wanted to exit Emerging Market economies/markets over recent years has now largely done so; therefore further significant depreciation of Emerging Market currency values is unlikely from here.

The near term focus of the local financial markets is the RBNZ’s Monetary Policy Statement on 10 December. The writer’s view is that if the NZD/USD exchange rate is around 0.6500 and whole milk powder prices near to US$2,200/MT then the RBNZ will be justified in holding off from any further OCR interest rate reductions.

If the NZ dollar was to appreciate to above 0.6800 and the dairy prices where to fall back to the previous lows of US$1,500/MT then a 0.25% OCR cut would be warranted as dairy farmer incomes and economic growth would be compromised again. However, such a scenario appears very unlikely over coming weeks.

The RBNZ will first want to observe the impact of earlier interest rate cuts, how the housing market adjusts to the new regulatory/tax regime and whether inflation is increasing in line with their forecasts for late 2015/early 2016. That information will not be fully available to them until February/March time.

Governor Wheeler will also want to wait and see the global financial and investment market’s reaction to the Federal Reserve’s interest rate hike on 17 December.

If NZ economic data had been weaker since the last MPS in September than the RBNZ might have reason to cut the OCR. However, the opposite is the case; economic data has generally been stronger. Employment growth for the September quarter was weaker than expected, however that economic measure is very backward looking and lagged. Latest job advert numbers and surveyed hiring intentions have been stronger. The RBNZ cannot ignore the fact the economy is tracking at a stronger pace than they anticipated a few months back, with tourism, services and construction particularly strong.

A further very important supporting factor for NZ dollar stability at 0.6500 is the performance of the Australian dollar over recent weeks.

The RBA has not cut their interest rates any further and employment growth has been impressive over recent months. The AUD/USD exchange rate has held firm at the 0.7100/0.7200 area despite a stronger USD and weaker hard commodity prices of late. The global investment sentiment towards Australia is slowly shifting to a more positive tone following a negative environment over recent years as investors worried about Australia’s exposure to a slowing Chinese economy.

As this column commented on back in August/September, the risk of the Chinese economy imploding was heavily over-stated at the time and global markets have since moved on from reacting to that perceived risk.

Elevated geo-political concerns following the IS terrorist events in Paris are generally positive for the US dollar in the currency markets. However, the re-engagement of the US with Russia in respect to the war against the IS terrorism is seen by the markets as a development that reduces international geo-political tensions, thus the USD has not strengthened further. 

The direction of whole milk powder dairy prices in early 2016 still stands as the dominant influence over NZD/USD exchange rate movements. Signs are that the Chinese buyers are returning for their seasonal milk powder requirements and thus further dairy price weakness is less likely.

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Daily exchange rates

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Roger J Kerr is a partner at PwC. 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