fxmatters

I should know by now … time waits for no-one. The RBNZ have gone onto the front foot, cutting the cash rate by 0.25% and signaling more to come. This reinforces the likelihood of a weak NZ dollar heading into the 11 September policy decision (and Monetary Policy Statement). I still draw attention to the high inflation pressures at present and suggest these will (a) constrain the RBNZ’s rate of policy easing and (b) probably delay any sizeable economic pickup until next year. This is not a local nor global predicament that will unfold quickly. But for now the RBNZ Governor has made his intentions clear: monetary policy is to be eased.

The NZD/USD dropped on the RBNZ announcement and was down 2.5% for the week. Not the largest drop, mind you with Czech koruna down 4.2%, but sizeable; and magnified by the general USD rally.

The biggest beneficiaries over the week were local ‘export’ shares, including F&P Healthcare +13.7%. Not only does each drop in the NZD (and local interest rates) help the earnings profile of these companies, it increases the chances of a takeover offer from abroad. There appears plenty of value left in the likes of F&P Appliances and Mainfreight yet.

The week ahead could see offshore forces dominate. There is little of major note expected here in NZ or Australia (sporting events excepted). The main action could come Thursday night when the US June quarter growth is reported. Signs that declining GDP has been averted in the US may provide a little more boost to the USD but more importantly keep the USD from plummeting and add to the odds that the NZD/USD trades a 70-75c range for some weeks.

We once again come to a Reserve Bank of NZ decision on the cash rate. Surprise is the only certainty with market pricing implying odds just over 50/50 of a rate cut. The RBNZ signaled in June that “we are now likely to be in a position to lower the OCR later this year” but it was probably the December quarter they had in mind, not the very next month. We learnt last week that inflation was higher than expected at 4.0% and most signs indicate that it will be even higher in the year to September (released October). It may well be that NZ is in recession but the RBNZ cannot be confident yet that an inflation spiral has been been avoided – my pick is that wait until September at least. This suggests some NZD firmness near-term.

The other key event this week is the Australian CPI release Wednesday. There the inflation rate is expected to hit 4.3%. The RBA too is worried about an inflation momentum developing. But the RBA Governor last week implicitly played down the prospect of another RBA rate hike in the next month or two, so a figure no worse than expectations could see the AUD drift lower near-term.

Add in the possibility of a firmer USD near-term following the recent drop in oil prices and rise in US share prices and the mixed forces are likely to show as a NZD/AUD working its way back up toward 80c, holding its own for now against the USD and firming against other currencies. In other words, biding time until the next wave of NZD selling.

The NZ dollar did generally rebound this week, primarily the result of the higher than expected 4.0% NZ inflation rate in the four quarters ending June, and hence reduced odds of an RBNZ easing 24 July. The NZD/USD even managed to top 77.5c at one stage (and the NZD/AUD top 79.2c).

Two thoughts arise: once again the advantage of placing orders to take advantage of any spike was displayed; and, second, the high inflation figure delays, rather than changes, the timing of any monetary policy easing.

The bigger picture is the local economy is in a slump and soon monetary policy will be eased. The current NZD rally – and any more should that emerge – present good selling opportunities. Market anticipation of a monetary easing is likely to build as we approach the next scheduled policy review on 11 September (with or without any rate cut next week).

Meanwhile one reason for the NZD/USD spike was the weak USD itself. Judging by the bias in option pricing, the market is fearful of even further USD weakness against the EUR. However it is not only the US economy (and NZ) that is slow at present. German business conditions are also slipping fast. Slow or negative growth in the big three economies of the US, Japan and the Eurozone make for ambiguous currency trends. It suggests some respect should be given to the significant bounce of the USD in the last day or two, and the significant drop of oil prices (recently associated with the USD trend).

The broad picture remains one of the EUR/USD trading sideways between $1.53-$1.60 approximately. It may be that the EUR/USD is in for a move towards the bottom of this range.

Put that possibility together with the soft local economy and conditions are shaping for the NZD/USD to finally fall back to the 70-75c range.

Last week the local focus was on recession. The NZD declined against most currencies with the notable exception of the US dollar (NZD/USD +0.3%). This week the attention will be on inflation (Calendar). Local inflation is undoubtedly high – the issues for markets is it any higher than the RBNZ’s 3.8% estimate, and will it deter the RBNZ from easing next week (Central Bank Watch)? The market is coming around to thinking that the RBNZ will ease anyway (Interest Rate Futures).

I think they have this wrong. The RBNZ has being fighting for over 3 years now to bring inflation back under control and yet the NZIER survey last week showed firms’ pricing intentions to be the highest in over 20 years. The NZD is likely to bounce a little this week and next as the market comes to see that the RBNZ cannot ease just yet.

Meanwhile the US housing situation continues to look bad and should outweigh any inflation concerns in the US, keeping the downward pressure on the USD.

The short of it all: the NZD/USD has not broken out of its 74.5-77.0 trading range yet and will probably push back towards the top of the range near-term. Any rallies should present good selling opportunities longer-term, though, as the slow local economy will come to hurt those who cannot see any other way than raising prices.

Early figures point to June as having been a slow month for NZ retailers. The combination of cold weather, short days, high petrol prices, high interest rates and falling share prices is taking its toll. But the National Bank June survey also shows more people intending to raise their prices. This mix of slow activity but strong inflation pressures is likely to be repeated in the NZIER survey released Tuesday (Calendar). With activity and prices seemingly determined to head in different directions, the RBNZ face a tough decision on the 24th (Central Bank Watch). The economy is slow enough to keep the bias towards an easing, although probably not this month.

The telling point for the NZD/AUD will probably come Thursday. Last month the Australian employment figures were weak. A similar report Thursday, coming after the on-hold RBA decision last week, could see the AUD drop, and cause the NZD/AUD to rebound to near 80c again.

The third major part of the NZ dollar equation is the US dollar. It rallied a little last week. But the lower US interest rates (Interest Rate Futures) and the still-weak share markets suggest the USD is more likely to weaken, rather than strengthen, at present.

The end result could be the NZD higher against the USD and AUD this week. But any rally is likely to be temporary, as the soft NZ economy sets the scene for a downward trending NZD over the second half of 2008.