By Roger J Kerr
The NZD/USD exchange rate has traded erratically up and down over recent weeks, however remaining within its defined trading range of 0.7100 and 0.7350, which has been established since the recovery from below 0.6900 in January.
The positive and negative forces that drive the Kiwi dollar’s direction appear to be reasonably evenly balanced at this time. The short to medium term outlook for the NZD/USD rate continues to be one of stability in the low 0.7000’s region.
As expected, the US dollar has re-exerted itself on the global stage after some weakness through January when the forex markets started to doubt the sustainability of the “Trump rally” and whether the President’s pre-election pledges would be delivered on (particularly tax cuts and infrastructure investment).
The President’s recent tweet that the US tax reforms would be “phenomenal” provided encouragement to the markets, equity markets rallied upwards with greater momentum and the US dollar bounced back from $1.0800 to $1.0600 against the Euro.
US economic data continues to print on the stronger side, supporting the Federal Reserve’s case for three 0.25% interest rate hikes this year. The probability of the first increase coming next month in March has increased over recent weeks.
Further US dollar strength to $1.0400 seems likely as the Euro weakens on political risk concerns from upcoming Dutch and French elections. The stronger US dollar outlook to $1.0400 against the Euro would push the Kiwi dollar back to 0.7000, however it would need some specific New Zealand negative risk event to force it below that level.
The local domestic economic factors continue to be positive for the Kiwi dollar, despite the Reserve Bank at their statement on 9 February being forced to rebuke the markets for being premature with interest rate increases in late 2017.
The Kiwi dollar depreciated two cents from 0.7350 to 0.7150 on the RBNZ’s lower 2017 inflation forecast and maintenance of the OCR at 1.75% for the next two years in their economic outlook/model assumptions.
The NZ dollar has certainly lost some enhanced yield return appeal to foreign investors with the US interest rate increases and NZ interest rate decreases in late 2016. Further US interest rate increase this year and stable NZ interest rates in 2017 are however already priced-in to the NZD/USD rate at 0.7180. The currency, however, does appear to be attracting some international capital inflows as a “safe haven” secure place to have your money in an uncertain and sometimes tumultuous world.
One reason why the NZ dollar may have very limited upside above 0.7200 over the coming period against the USD is that the Kiwi generally follows the Australian dollar movements against the USD.
The AUD/USD rate has rebounded back to the top of its trading range at 0.7700, however over the last few years the Aussie dollar has encountered a serious ceiling at this level and has always reversed back to lower levels.
The AUD has appreciated on higher base metal commodity prices over recent weeks and confirmation from the Reserve Bank of Australia that they are on “neutral-hold” with monetary policy (i.e. no more OCR cuts).
Positive Chinese economic data has cemented in the commodity price gains for iron ore and copper. However, a correction back down in these commodity prices on profit-taking from the speculative side of the market may well push the AUD/USD rate lower. Likewise, the AUD/USD is highly correlated to the share price movements of listed mining/resources stocks in Australia and it would not be surprising to see offshore investors selling out of both Australian equities and the AUD as they take their profits home.
Whilst all the aforementioned positive and negative forces balance each other out and leave the Kiwi dollar relatively stable, the residual and wildcard variable is always the fortunes of our largest commodity in the form of dairy prices.
The spectacular recovery upwards in whole milk powder (WMP) prices from US$2,000/MT to US$3,500/MT late last year has run out of steam this year as the supply and demand developments even out.
The last two Global Dairy Trade auctions have produced no change in prices after the 7% drop in WMP in early January. There is more product volume than earlier expected being placed in the next auction on Tuesday 21st February (results Wednesday morning here in New Zealand). There are also reports of Chinese import warehouses being full up with milk powder.
Therefore, further corrections downwards in WMP prices over coming weeks/months may be the one catalyst (if it occurs) that propels the Kiwi dollar back to below 0.7000. However, a major WMP price collapse, similar to what occurred in 2014 through to 2016, is not anticipated as supply volumes out of both NZ and Europe have reduced.
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