Roger J Kerr says the New Zealand dollar may fall as low as US68c sooner than most people expect

By Roger J Kerr

It is a long way from a UK Sterling “flash crash”, however the NZ dollar continues to retreat against the US dollar at a much faster pace than the previous uptrend.

Comparisons to earlier “up the stairs/down the elevator shaft” price patterns that the Kiwi dollar is renowned for are starting to emerge as the NZD/USD rate drops sharply after months of slow appreciation.

The Kiwi traded to a low of 0.7111 on Friday 7 October after reaching a high 0.7470 a month earlier on 8 September.

It took 12 months of the NZ dollar to appreciate 12 cents (19%) from 0.6270 in September 2015 to 0.7470 last month. It has only taken one month to fall 3.6 cents (5%) as investors into the Kiwi start to take their profits and unwind their long positions.

As stated before in this column, the NZ dollar behaves in this fashion due to offshore investors/speculators progressively building up long NZ dollar positions over time. However, when the time comes to exit, the same investors all rush the door at once and the daily FX market liquidity is not necessarily sufficient to handle the volumes of NZ dollars being sold. Therefore exaggerated falls are the result as fresh NZD buyers are scarce and a one-sided market develops.

So, what factors are behind the current change of heart towards the NZ dollar to cause the sudden depreciation?

• Stop loss sell NZD orders were triggered just above 0.7200 last week when the NZD/USD rate broke below key chart/technical levels of the 50-day moving average and uptrend support lines.
• Offshore investors taking advantage of New Zealand’s higher interest rate yields compared to USD interest rates have seen that yield return premium reduce from 2.5% 12 months ago to just 1% today (two-year swap interest rate differentials). A major reason for holding Kiwi dollars has reduced in its attraction. With the RBNZ due to cut official interest rates again next month and the US Federal Reserve doing the opposite in December, the NZD carry trade has certainly lost its lustre.
• Offshore portfolio investor buying has played a major role in pushing the NZ sharemarket progressively higher over the last two years. A relatively high performing economy and higher dividend yields on offer compared to other equity markets added to the incentive to buy New Zealand shares. The proportion of offshore ownership of NZ shares has consequently increases from 25% to 50% of the market over the two year period. Risk/reward equations being calculated by these foreign investors now has them reducing their NZ weightings as they bank their considerable gains on both the shares and currency. The disinvestment out of NZ equities is adding to the downward momentum as the offshore players sell their NZ dollars.
• Over the last 12 months the rise of the NZD/USD exchange rate front-ran the ultimate improvement (albeit belatedly) in global dairy commodity prices seen over recent months. The NZD/USD rate and Whole Milk Powder (WMP) prices in USD’s are highly correlated due to dairy being a dominant force in the NZ economy. However, the dairy futures markets have been somewhat wayward in picking GDT auction price results of late, therefore recent WMP price falls have been somewhat of a surprise. The Kiwi dropped over one cent last Tuesday when the WMP price at the GDT auction pulled back 4%. The rapid increase in WMP prices over recent weeks has arguably been “too far, too fast”, the real test for the sustainability of dairy price increases will come when full milk production volumes come on stream in January.
• Unwinding of trans-Tasman long Kiwi/short AUD positions that drove the NZD/AUD cross- rate from 0.9000 to 0.9700 has also been a source of individual NZ dollar selling over recent times. The NZD/AUD cross-rate has reversed sharply from above 0.9700 to 0.9430.

What is instructive about the latest pullback in the Kiwi dollar is that it has come at a time when local economic data has been impressively strong.

Business confidence levels, employment numbers and overall GDP growth continue to paint a very positive picture for the current conditions and outlook for the NZ economy.

However, the combination of unrealised FX gains in the books of foreign investors and a propensity to reduce risk positions ahead of the US Presidential elections in early November, means the Kiwi is being sold despite the positive NZ economic news flow.

The US dollar itself continues to move sideways on global FX markets. Rising US interest rates in December still suggests a stronger USD against the Euro in the lead up to the Fed announcement.

The next major support level for the Kiwi dollar against the USD is 0.7000, a break below this point may see 0.6800 sooner than most would expect.

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