A game of two halves

Roger J Kerr, April 15th, 2009

In the clichéd rugby vernacular, it appears to be “a game of two halves” for the Kiwi dollar currency movements over the next 12 months. While having made impressive gains to 0.5900 from the low 0.5000’s over recent weeks there are a number of short-term forces and events that suggest the NZD/USD exchange rate will not sustain its gains and return to the low 0.5000’s.

However in the medium term to longer term (the latter part of 2009 and into 2010) against a back-drop of an improving New Zealand economy and potentially local interest rates increasing ahead in timing of other countries, the Kiwi has a far higher probability to be appreciating above 0.6000.

First Half: Bollard, English and Greenback restrict scoring opportunities

The short-term variables revolve around local interest rates/monetary policy, the USD exchange rate on global markets and the Government’s budget at the end of May.

RBNZ Governor resorted to some good old-fashioned “open mouth” monetary operations two weeks ago as he attempted to jawbone both interest rates and the NZ dollar downwards. His view was that the recent increases were inconsistent with his desirable monetary policy settings and that the economic recovery could be threatened if monetary conditions move away from the required “super-loose” position.

The verbal intervention only had a very brief impact on the NZD currency market. The Kiwi fell to 0.5600 from 0.5700 on the day, but has since returned to above 0.5800 as global investor sentiment improved and the NZD is finding some overseas investor favour.

The term swap interest rates were increasing due to one-sided fixed paying demand, as both household mortgage borrowers and large corporate borrowers rushed to secure fixed rates as they believed that the interest rate cycle has bottomed.

The RBNZ themselves caused this view about future interest rate direction by stating in their early March Monetary Policy Statement that “New Zealand’s capital markets must remain competitive”. The moneymarkets and borrowers took that to mean that our interest rates could not go too far below Australia’s as we need to still attract voluntary foreign capital inflows to fund the massive $16 billion current account deficit.

The RBNZ statements added to the volatility of interest rates and exchange rates in recent times, just at a time in the economic recession that businesses and industry sectors are crying out for stability and certainty.

The RBNZ now seem more likely to cut the OCR interest rates from 3.00% to 2.75% or 2.50% later this month. That action may cause some independent NZD selling, but the markets should have already priced this eventuality into the rate. Any RBNZ interest rate reductions in April and May will be the last. Term swap interest rates beyond three years are unlikely to fall on these last OCR adjustments downwards.

The second potential short-term negative factor for the NZD/USD rate is a stronger USD/weaker euro on global FX markets. The USD has already recovered from $1.3700 against the euro to $1.3100 as expectations mount that the European Central Bank will be forced to cut its official interest rates form the current 1.25% to zero over coming months. Lower interest rates in Europe and a closing of the differential to US interest rates should return the USD/EUR rate to $1.2500. The stronger USD should drive the kiwi to 0.5500 and below, but the NZD cross-rates to GBP, EUR, JPY and AUD are unlikely to fall - more likely to be stable to higher. The weaker euro has already lifted the NZD/EUR cross rate from 0.4000 to above 0.4400 in recent weeks.

The third factor that some believe will be negative for the Kiwi is the risk of NZ Government sovereign credit rating downgrade after the budget at the end of May. In the author’s opinion, Finance Minister Bill English will meet Standard & Poor’s expectations of controlling the size of the Government’s deficit and debt increases over coming years. It may take a suspension of annual payments to the NZ Superannuation Fund to make the numbers work, but the Government knows full well that it must avoid a credit rating downgrade at all costs. The NZ Government needs to compete against other Government debt issuers for investor support over coming years, maintaining our AAA rating is imperative to that strategy. Those currency market players short-selling the NZD going into the budget and expecting a rating downgrade will be disappointed.

The NZD/USD exchange rate is expected to hold above 0.5000 over coming months, but not trade above 0.6000.

Second Half: Forwards on top, backs find wide open spaces

Further out into late 2009/early 2010 the following factors suggest an appreciation in the NZD to above 0.6000:

• NZ economy coming out of recession on an export-led recovery in late 2009 – earlier than Australia and other countries,
  
• NZ interest rates rising later in the year, ahead of all other countries, the interest rate differential to the US moving upwards,
  
• Our commodity prices continuing to stabilise over coming months,
  
• Net migration inflows increasing as fewer Kiwis leave and more ex-pats return,
  
• The Balance of Payments current account deficit reducing over the next 12 months from 9% of GDP to 5% as profits of foreign owned companies here reduce substantially and the trade balance moves into surplus with weaker imports and stronger exports.

Excellent commentary from Roger Kerr, his thoughts are entirely in line with mine! - KT