By Roger J Kerr
The 23 cent depreciation of the NZ dollar from US88 cents to US65c over the last 12 months was due to a variety of factors that arguably will not be repeated over the next 12 months.
Picking the exact bottom of the downward movement is fraught with danger; however, at the current spot rate of US65c we must be approaching a level where fresh new speculative sellers of the currency should start to dwindle in number. The FX market is very short-sold NZ dollars in their positioning at this point in time and unless new lows are reached there will inevitably be a bounce back upwards on profit-taking (i.e. buying back of the Kiwi dollars).
The New Zealand currency has been battered of late with a series of poor economic outcomes driving the negative sentiment and selling – tumbling dairy prices, falling global share indices, low inflation, lower GDP growth, cuts to local interest rates, falling business/consumer confidence levels, a weaker AUD and a generally stronger USD.
Looking ahead, the question is whether the forex market has exhausted itself with re-rating the NZ economy from “Rock-Star” status to something more ordinary. The good news for our economy is that the automatic stabilisation/shock absorber mechanisms that our free floating exchange rate regime delivers when our key export commodity price plunges, are working very well. The weaker NZD value partly compensating the plummet in wholemilk powder prices to reduce the negative impact on exporter/farmer returns. Of course, dairy exporters already have currency hedging contracts in place at higher NZD/USD levels for the next six to 12 months, so the full benefit of the lower 0.6500 exchange rate will be muted in the short to medium term.
Over its history as a free-float exchange rate since 1985, the Kiwi dollar has displayed a tendency to over-shoot on both the top-side and bottom-side. It was downward spiralling export commodity prices and rapid cuts to interest rates that caused an over-shooting to US50c at the time of the GFC in 2009. Within 12 months of bottoming at US50c in early 2009 the NZD/USD rate had bounced up 22 cents to US72c. There are no expectations that this will re-occur on this occasion, however there are five reasonable reasons why we may be approaching “over-shoot” territory to the downside once again:-
- Dairy prices will recover – The inventory overhang in China still appears to be a factor holding prices down over the next three to six months, however, beyond that timeframe the global supply/demand equation starts to even up. The smart food manufacturers who are the end users will start to hedge/buy well before that time and the incentive for US and European milk powder producers to export is just not there anymore with WMP prices below USD2,000/MT.
- Interest rate cuts already fully-priced in – Economic data points to two of three more 0.25% OCR cuts by the RBNZ, the FX markets have already built this in to current pricing and thus further NZD selling on the actual reductions is unlikely.
- USD gains on rising interest rates fully priced in – The USD Currency Index has already appreciated 38% from 71 in 2008 to 98 today on the expectation that US monetary policy will eventually be returned to normal and US interest rates will be higher. Federal Reserve boss Janet Yellen is taking a slow and measured adjustment process to higher US interest rates so as not to scare the FX and equity market horses. Further significant US dollar appreciation seems unlikely.
- Euro should stabilise around $1.05/$1.10 to the USD – Greece did not default and was not kicked out of the Euro. Euro-land economic growth is slowly improving, thus no real need for any further sell-off in the Euro currency value.
- Markets have over-reacted to Chinese factors? – The more negative economic and sharemarket news coming out of China has depressed hard commodity prices and the AUD. Sign are emerging of some stabilisation in the rate of slowdown in Chinese economic data as their lower interest rates help activity levels, thus the markets may have over-reacted.
Our Prime Minister (being a former currency trader) correctly picked the NZD appreciation to US88c and subsequent demise to US65c. He is now defending the economy as it seems the majority of local commentators have become overly-pessimistic. It is likely that we will not know where the NZD/USD bottomed-out until it is four to five cents higher than the actual bottom. For this reason exporters have to be averaging into longer-dated hedging on the way down, as it is just too hard to do it on the way back up. Movements over the next three months will determine just where the bottom is and thus set the pattern for the next 12 months.
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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