Roger J Kerr says it is hard to say the NZ dollar should be declining as the economy stays strong, while questions are being asked whether the new US administration can deliver on election promises

By Roger J Kerr

The NZD/USD exchange rate traded to a low of 0.6870 on Christmas Eve 2016, however due to a variety of factors the downward momentum at that time has not continued and over this last week the Kiwi has rebounded upwards to 0.7130.

Global currency shifts, in particular a dramatic turnaround in the fortunes of the close cousin currency the Australian dollar, have reversed the Kiwi dollar’s direction and caused the gains back above 0.7100.

New Zealand domestic economic data continues to print strongly and it is hard to offer an argument that the share price on the NZ economy, the NZD currency value, should be declining when the relative economic performance is so strong.

Historically, the NZ dollar does appreciate in January as thin/illiquid wholesale FX markets allow local dairy/meat export industry NZD trade buying of Kiwi dollars to dominate market flows and thus rate direction.

The Trump victory-inspired US dollar rally that commenced in mid-November has definitely run out of steam as we enter the New Year. US shares and the USD were heavily bought in the weeks following the Trump Presidential win, however the trade had become very crowded by year-end and what we have seen in recent weeks is traders/investors taking profits and thus becoming sellers of shares and the USD.

The USD made impressive gains against the Euro to $1.0400 prior to Xmas, however the profit-taking has sent to the EUR/USD rate back to $1.0650 currently.

Questions are rightly being posed by the markets in the lead up to the President Trump inauguration on 20 January as to whether the new Trump administration in the US can actually deliver to the economic policy promises made in the election campaign.

It was originally thought that a Republican Party domination of the Senate and House of Representatives would allow for ease of implementation of the Trump economic policy promises of lower corporate taxes, infrastructure investment and import protectionism.

However, signs are already appearing that the Trump relationship with key Republican politicians to implement policy will not all be plain sailing.

In addition, the temperamental messages from Donald Trump via his Twitter feed on trade and foreign relations has the US driving geo-political uncertainties that the financial markets are starting to get jittery about.

Certainly, the emerging war of words between the US and China on trade and currency value matters can only intensify and this will lead to more volatility in the markets.

It appears that the US dollar will only re-exert itself to another bout of strength if the forex markets take confidence that President Trump can get his policies implemented.

On the other side, there is no real reason for the US dollar to be further sold against the major currencies. Increasing US interest rates this year stand in stark contrast to negative interest rates in Europe and this factor along is very US dollar positive. Therefore, USD exchange rate direction over coming months will be heavily influenced by the progress (or lack of progress) the Trump administration makes in implementing the new policies.

Through November and December the Aussie dollar was slammed down hard by the markets as the potential trade disruptions between China and the US from Trump’s protectionist agenda was seen as negative for the Chinese export sector, thus negative for Australia who supplies the raw materials to China.

The AUD/USD rate reached a low of 0.7160 prior to Christmas, the weaker Aussie dollar at that timer was completely at odds with rising hard commodity prices which normally cause a stronger AUD. However, over recent weeks the FX markets have realised how much to AUD was unjustifiably over-sold and a massive rebound back to 0.7500 against the USD has occurred.

The NZD/AUD cross-rate has been pulled back from highs of 0.9650 to 0.9500 by the latest AUD appreciation. The interest rate differentials and commodity price differentials between Australia and New Zealand still suggest that the NZD/AUD cross-rate is substantially over-valued at 0.9500.

Another fall in wholemilk powder prices at this Wednesday’s GDT dairy auction may remind the markets of this currency misalignment. It does appear that wholemilk powder prices ramped up too far, too quickly late last year and the true global demand/supply situation would become more obvious in the January/February period when traded volumes are higher.

The UK Pound Sterling has today traded below $1.2000 against the USD for the first time since the Brexit and flash crash in Sterling in mid-2016. It appears that the UK Government and the EU are headed for a “hard-Brexit” process which is negative for the UK economy. The NZD/GBP cross-rate has jumped from 0.5650 to 0.5930 as a result.

Local exporters who had FX orders placed between 0.7000 and 0.6850 to increase hedge levels have been well rewarded for their discipline and are well protected against a potential higher Kiwi (lower USD) if the USD Trump rally turns into a full “Trump Slump”. 

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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