fxmatters

Extreme movements in financial markets continue. The 5.1% NZD/USD gain last week was only exceeded once (week ending 19-Jun-98) in the last 15 years. But a sharp move does not necessarily set the trend for the next few weeks: back in 1998 the NZD/USD was much the same 4 weeks later after the weekly surge; the same could happen this time.

The underlying cause of the sharp shift was a weaker USD last week. This has been brewing for a while – see Danske Bank for background forces – with widening interest rate differentials in Europe’s favour a key factor. But, looking ahead, both Danske Bank and Morgan Stanley refer to potential difficulties for Europe. Meanwhile the Japanese government is likely to resist an even stronger JPY (i.e. weaker USD/JPY). These factors suggest choppiness for the major currencies ahead, rather than one consistent direction over 2009.

That makes for a choppy NZD next year as well, even if the local economy remains weak and the RBNZ continues to ease (as implied by Futures). Exporters would be well to buy on dips for medium-term needs even if many people are still predicting a lower NZD.

In the near-term it is importers that may be presented with better opportunities. Volatility has tended to increase during these times of thin markets, although it is difficult to see how volatility can get much greater! Any NZD rise above 60 US cents and 85 AU cents would appear attractive selling levels given an outlook for choppy global currency markets and lower NZ interest rates.

Merry Xmas.

The US dollar rebound finally came last week i.e. the USD dropped after having appreciated very strongly since mid July. Significantly the EUR/USD gained 5.1%, breaking above the range of the previous six weeks. The momentum was not enough for the NZD/USD to emerge from its recent range but such a break is likely.

The key factor will be the EUR/USD. The move last week was largely the result of a widening interest rate differential as even lower interest rates are anticipated in the US – including a 0.25% or 0.5% cut Wednesday morning – coming at a time that questions are being raised as to whether the ECB will be as aggressive, and against a backdrop of continued disturbing news from the US. It does appear that the USD tide has turned for now and an NZD/USD nearer 60c is likely in the next few weeks.

More generally currency markets are likely to trade within broad sideways patterns in the next 2-3 months. There will undoubtedly be more bad news from Europe to come, and hence EUR weakness at the time. The Japanese authorities will eventually resist a weaker USD/JPY. The choppiness produced by these three major currencies will set the tone for exchange rates such as the NZD/USD, NZD/EUR and NZD/JPY. Such an outlook suggests placing orders to sell NZD/USD above 57c and buying below 53c for medium-term requirements.

What a tug of war currency markets are proving to be. The short of it all is that the NZD remains within recent ranges against the USD and GBP but is drifting lower against the AUD, EUR and JPY.

The key driving force remains global sharemarkets, the link to the NZD coming through the AUD. While global share indices were down again last week, the last move of the week was upward on Friday night, in spite of news that US November job loses was the largest monthly decline in 34 years. That about sums up markets at present: there is so much ‘bad’ news factored into prices that volatility is likely rather than one-way downward trends for shares, the AUD and NZD.

The same logic applies to other key factors such as oil prices (down 25% last week) and the JPY/USD (+2.9%). The blame for lower oil prices was put on weak global growth prospects but such a sharp decline also appears to be of the panic/over-shooting nature and leaves less scope for more ‘bad’ news to impact. The JPY/USD is now once again near the 90 yen level that has brought strong exchange rate intervention in the past.

With so much panic around there is always the risk that some small event could trigger another sharp NZD decline, especially against a backdrop of further RBNZ rate cuts to come (see Interest rate futures).

But conditions remain poised for a sharp rebound to the trend of the last 20 weeks (during which US S&P500 -31% and NZD/JPY -39%), even if the medium-term trend remains flat-to-downward.

Viewed another way, local interest rates are falling and the local economy is in recession but interest rates are also falling sharply elsewhere (including last week Australia -0.75%, Indonesia -0.25%, UK -1.0%, Euro-zone -0.75% and Sweden -1.75%) and recession is a global trend (including the first simultaneous US, EU and Japanese recession since WWII). Looking in from the outside, NZ is not too bad – relatively.

This week there will be plenty of news from Australia. The week started with another fiscal stimulus. Tomorrow the RBA is expected to add to the monetary stimulus with a 0.75% cut to provide a 4.5% cash rate. Wednesday we will probably learn that the Australian economy is still growing – just! – while a series of other data released during the week will show likewise (see Calendar). All in all, the Australian economy is coping reasonably well with the global shock – if only the rest of the world were the same.

As it turns out, there was a mood change last week in global markets. The US S&P500 Index was up 12% (and a few local stocks ended with double-digit gains). The US government lobbed even more funds into the banking sector. The Chinese cut rates again. The British and Europeans will cut rates this week.

These changes have the potential to create a sharp rebound in currency markets. Not only can the nascent optimism prove catchy, but rate cuts often have perverse impacts on exchange rates, after the fact. And just as the AUD was to the fore of the currency drop, it is likely to be to the fore of any rebound. As always, nothing is certain about the future but the odds are building for a stronger AUD, and hence a generally stronger NZD versus other currencies as the NZD follows, albeit reluctantly.

The reluctance comes from the NZ economy in recession and the RBNZ likely to narrow the gap – actual and anticipated (see Interest Rate Futures) – between trans-Tasman interest rates this week: a lower NZD/AUD appears in store.

Share prices and currencies such as the NZD and AUD again moved in tandem last week – downward – but with one major difference: exchange rates such as the AUD/USD, EUR/JPY and USD/JPY failed to breach the lows of recent weeks. These patterns point to buyers – including governments – willing to commit at current levels, and are suggestive of a low point for these exchange rates.

Such a base would in turn limit the downside for the NZD near-term (with the notable exception of the NZD/AUD). It is worth noting that the NZD is now 25% below-average against the JPY and 11% lower against the USD. To be sure, wider swings are possible but the combination of rapid currency falls already in recent months and weak offshore conditions make the NZD look attractive for medium-term needs over the next year or two.

In the short-term, there remains the risk of more financial market panic and there are the RBA and RBNZ rate cuts to experience. Both are expected to cut by at least 1% next week with the RBNZ more likely to cut the greater amount. These moves would typically create a downward bias to the respective exchange rates ahead of the event.

Put these thoughts together with the observation that the NZD/USD is typically trading ranges around 5c per week at present points and the appealing strategy is placing orders to buy USD just above 50c.

Markets are notoriously sensitive to small events. Right now appears to be a case in point.

Financial markets have generally tracked sideways in most recent weeks, albeit in a whippy fashion and over a wide range. The major exceptions are oil, the GBP and the Indonesian rupiah, and short-term interest rates which are each still in freefall. Today there are a number of shares and currencies moving towards levels that suggest another more general bout of freefall; any minor event could set the panic in motion. However there has been an enormous amount of government action (even if the G-20 weekend response was lame) and narrower bank credit spreads point to better functioning global money markets. What’s more, coordinated currency intervention is likely should the JPY in particular appreciate further (and the likes of the EUR, AUD and NZD depreciate). Thus a continuation of the broad sideways pattern for exchange rates in general appears the more likely outcome in the next few weeks.

Closer to home, another pivotal event will be the RBNZ monetary policy decision to be announced 4-December. The market is expecting a 1% reduction in the cash rate to 5.5%. In the meantime the RBA is likely to reduce the Australian cash rate by a further 0.5% to 4.75%. More importantly (for currencies) the market is now pricing short-term rates to reach 3.5% in Australia but only 5.2% in New Zealand (see interest rate futures). Such a gap is anomalous with relative growth and inflation prospects and is likely to narrow, dragging the NZD/AUD closer to 80c; should the RBNZ surprise with a more hawkish stance then it will be 90c that becomes the magnet.

The massive response by governments to the global financial crisis continued last week with official rate cuts in Europe, UK, Switzerland and Australia – the later three including an element of surprise. There was also monetary loosening in China, and a huge fiscal package announced (detail). These policies have not yet stemmed the downward share price trend but there has been consolidation in the currency markets. This currency pattern is expected to persist, resulting in the AUD leading the NZD generally higher against other currencies in the near-term.

The US and NZ election results may be dominating media and public attention but they remain well down the order of influencing factors in the currency markets at present.

Longer-term it is difficult to foresee any quick, vigourous turnaround for the US and NZ economies, and hence weakness for both currencies is likely within the next six months. However a weak USD next year would limit the extent that the NZD/USD depreciates, adding to the appeal of forward buying of NZD/USD for medium-term exporters’ needs at present.

It appears that the panic has passed, although one cannot be sure. The massive government support to money markets now has bank risk measures such as the LIBOR premium to official rates trending down. The intervention by some governments in the currency markets helped turned the upward JPY and downward AUD trends around.

The policy adjustment continues this week with the RBA (today) and the BOE and ECB (Thursday) expected to cut their target interest rates by another 0.5% (see current official rates).

Again no certainties, but exchange rates such as the USD/JPY under 95, the AUD/USD below 64, the NZD/USD below 56 and the NZD/AUD above 91 now look like over-shooting. The USD/JPY rate in particular is likely to remain above 90 yen (although the 1995 yen surge did get near 80). Of local significance, it is this JPY buying and inter-related AUD selling that has been the strong driving force for the NZD.

This leads to thinking about where the NZD will settle after the panic (not that exchange rates ever truly settle). The RBA decision today could be pivotal. The RBA Deputy Governor Battellino was last week playing up the prospects for the Australian economy, and playing down the need for large rate cuts beyond today. The combination of less panicked markets and less certainty around future RBA rate cuts is likely to see the AUD/USD back above 70c, and hence the NZD/USD trading in the 60-65c range.

Another week of anxiety, and the question still hangs are we on the cusp of a severe global recession? The markets seem to think so: the US S&P500 share index -7%, and many other share indices in double digit declines; copper -22% and oil -12%; and currencies such as the AUD and ZAR -10% while the JPY was +8%. Caught in this wave the NZD/USD -9% and NZD/JPY -16% were astounding but at least consistent with international trends. The impact of the RBNZ 1.0% rate cut was simply swamped by global events.

In contrast, the words coming from central bank heads, while negative, are reassuring: Australian Governor Stevens judges that “the likelihood of a global catastrophe has in fact declined over the past couple of weeks”; New Zealand Governor Bollard summarised the global situation as “a nasty financial event but, so far, not a hugely nasty economic event”; and Canadian Governor Carney notes “the global economy appears to be heading into a mild recession”.

If the central bankers are correct – and I put more weigh in the mild rather than severe global recession outlook – then markets are over-reacting. That need not stop share prices and the NZD falling further in the short-term. Markets are renowned for over-shooting.

These comments will be of little help to currency managers in the short-term, other than to encourage a rethink of the consequences of extreme NZD movements for your business or investment. The necessary action may well drop out of such an exercise.

Otherwise, in my opinion, the strategies of appeal are (1) exporters and investors embarking on a strategy accumulating shares and NZDs (except against the AUD) for the medium term (2) importers and investors accumulating AUD (i.e. sell NZD) and (3) all parties leaving opportunistic orders in the market to take advantage of the volatility.

In the week ahead, the key scheduled event will the the US Fed monetary policy decision Thursday morning (NZ time); a 0.5% cash rate target cut to 1.0% p.a. is now expected, although perversely a 0.25% cut may be more reassuring. The other matter to be mindful of is central bank intervention may soon extend to selling JPY in a coordinated way.

On a lighter note, this BBC ’sub-prime interview’ brought to my attention will amuse.

It has come round to the RBNZ’s turn now: the OCR will be cut on Thursday, and probably by 1%. This will not come as any surprise and hence not cause a large currency reaction but it probably keep a downward bias to the NZD/AUD this week.

Before then the latest CPI releases from NZ and Australia are due (see calendar). Both are likely to show annual inflation near 5%. But that should be the peak rate as the local recession and the likely global recession make it very difficult for those putting prices up to maintain sales (which ultimately ends in discounting). In other words, these releases are unlikely to deter the respective Reserve Banks from easing monetary policy further; a lower than expected figure may heighten rate cut anticipations.

The major uncertainty is still the global financial situation. There was a rebound last week – a case of very nervous and tentative buying in the major global markets. The S&P500 was up 4.6%. Consistent with recent trends, the AUD/USD was up 7.1% and the NZD/USD 3.0%. Remarkably the major exchange rate – the EUR/USD – was unchanged by week end.

With over US$3 trillion pledged by governments to support the financial system now, and with the US Fed likely to cut the cash rate again next week, the balance of risks appear biased towards the financial mood improving further this week. In contrast to the RBNZ driving force, such a development would push the NZD higher. Hence NZD weakness might be restricted to against the AUD near this RBNZ easing.