By Roger J Kerr
The New Zealand dollar has posted further impressive gains against all currencies over this last week, buoyed by a delayed reaction to the massive bounce back upwards in our key commodity export, wholemilk powder (WMP) prices, and a delayed realisation that the widely expected NZ dollar falls were just not happening.
Last Friday’s CPI inflation figures for the September quarter had the potential to send the NZD/USD exchange rate back down from the gains to 0.6880. However, the outcome was above, not below, the prior forecasts of a 0.3% increase in prices over the quarter.
The Kiwi has retreated somewhat to 0.6800 at the time of writing; however the overall appreciation from 0.6250 on 24 September to 0.6880 on 16 October caught most by surprise and proves that the currency was unsustainably oversold when WMP prices had reversed back up earlier in September. We have previously witnessed a delayed reaction by offshore players in the NZ dollar to WMP price movements; they are not as close to week to week commodity price movements as we are in New Zealand.
From a technical/chartist trading perspective once the Kiwi dollar spot rate broke up through the 50-day moving average just below 0.6500, additional buying (or closing of existing short sold speculative positions) was always going to send it higher. The charts provide clear blue sky for the NZ dollar to climb all the way up to 0.7000, however it does feel like that the appreciation from 0.6250 to 0.6800 has been too far, too fast.
The rise in the NZD/AUD cross-rate to 0.9380 also appears well over-done, particularly as the ever-reliable lead-indicator for the cross-rate, the differential in the two-year swap interest rates of Australia and New Zealand still points to a 0.8900 rate. I would expect major profit-taking action (i.e. NZD selling) from those that have purchased the Kiwi against the Aussie dollar over recent weeks. At 0.9380 it is an opportune time for those entities that currency hedge AUD assets to reduce the percentage hedged.
The outlook for the NZD/AUD cross-rate is almost entirely based on the future direction of both countries’ interest rates and export commodity prices. The current two-year swap interest rates for both Australia and New Zealand already price in two further OCR cuts for Australia and one OCR cut for New Zealand. In the commodity price stakes, our WMP prices need to consolidate the recent spectacular gains and Australia’s mining/resources are heavily dependent upon Chinese economic data. A stabilisation in Chinese industrial production, retail sales and GDP data early this week may restore some confidence that the Chinese economy is not in for a hard landing and Australia’s commodity prices should find some support.
Whilst we have been forecasting an eventual NZ dollar recovery to above 0.7000, it appears still to be too early for this to occur.
A more probable scenario over coming months is that the NZD/USD exchange rate range trades between 0.6500 and 0.6800 until the economic data in Australia and New Zealand discounts or confirms further interest rate cuts by the respective central banks.
The RBNZ slashed interest rates in June/July due to the collapse in dairy prices and the adverse impact of that on the overall economy.
Dairy prices have fully recovered their falls, therefore the only justification remaining for the RBNZ to cut the OCR to 2.50% in December or January is inflation outcomes well below their forecasts (not happening so far) or the El Nino weather patterns causing severe summer drought and decimating agriculture production (remains to be seen). If the summer drought hits the Waikato province hard, then the economy and currency will have problems.
If and when the RBNZ rule out any further interest rate cuts, the Kiwi dollar will be ready to move back above 0.7000.
On the positive side, an All Blacks victory at the Rugby World Cup in two weeks’ time will send nationwide psychological confidence and happiness into the stratosphere, providing another boost for the economy.
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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