fxmatters

It is now official: the NZ economy was in recession first half 2008. We probably still are. But this is no surprise and simply confirms the RBNZ assumptions. The RBNZ are showing a keenness to ease and have signaled another 0.5% OCR cut over the next 12 months, probably sooner rather than later.

Speculation that the cuts will come early will mount as we approach the 23 October OCR Review, and hence local forces on the NZ dollar around mid October will probably be downward.

Before then, though, the local news of late has tended to be a little more positive, a sentiment that will probably come through in the widely-watched 7 October Quarterly Business Opinion Survey. Even the lower dairy farmer payout is offset to some extent by the higher meat prices of late. And a good growing season would go someway to offsetting the lower dairy prices.

Internationally the forces are very mixed, suggestive of a wide-ranging but broadly sideways trading USD for the next few months. Near-term direction will depend on the specifics of the bailout package.

Put the two forces together and selling the NZD on any rallies still appeals.

The RBNZ surprised with an aggressive 0.5% cash rate cut to 7.5% p.a., and yet the NZD/USD is down a mere 0.1% over the week. Quite simply there were bigger fish out there, namely the USD itself.

Nonetheless the local economy is in recession according to the RBNZ. The RB do intend to cut the cash rate again, explicitly stating “we have brought forward some of the projected interest rate reduction, but have not altered the expected overall decline” (a decline implied to take the OCR to near 6.5% p.a. and the market pricing most of this within six months – see Futures). There seems little prospect of any sharp growth pickup to prevent these rate cuts. The NZD trend is likely to remain downwards in the next few months. In the near-term it is the NZD/AUD that stands out as the currency most likely to depreciate.

As for the NZD/USD near-term, the market started unwinding last week some of the recent large global moves of the previous 7 weeks. This has been overdue and USD weakness will probably continue near-term, particularly if speculation of a US Fed rate cut increases ahead of the Tuesday FOMC decision (see calendar). This could provide some attractive selling levels for the NZD/USD.

Almost 12 months ago to the day The Economist warned “we will see asset classes that will have very good runs (commodities, high-yield debt, currencies like the New Zealand dollar) only to lose a good deal of those gains in a short period”, the result of hedge fund activity. They were right. The goings-on of recent weeks appears very much in the category of speculators unwinding positions, especially in commodities and the AUD. Add to that list the EUR. The NZD has simply been dragged along for the ride with the telling statistic being the NZD/AUD being much the same now as 7 weeks ago when this phase started.

Meanwhile the common phrase being bandied about by central bankers is heightened uncertainty. They also are right.

So what will the RBNZ do Thursday against this backdrop? The conservative approach would be to follow through with the 0.25% rate cut now expected by the market. The greater risk is that the RBNZ take a more aggressive stance and cut by 0.5%. This suggests potential for currency weakness going into Thursday (at least against the AUD) but possibly a NZD rebound afterward if the RBNZ do take the conservative approach.

However it may be global forces that dominate. The huge global shift in currencies is not matched by compelling economic fundamentals. The ECB appear on hold and are talking gradual recovery. The US banks and economy are still in difficulty. The Australian growth outlook remains better than most. It all has the makings of a sharp rebound when the panic stage passes.

This will not take away the downward trend that the NZD is now on. But, as usual, there will be plenty of choppiness along the way.

The scene for the NZ dollar will be set offshore this week. It is the RBNZ’s turn next week.

Remarkably the Australian economy will report a 17-year run of growth this week (last recession ended mid 1991). That’s an exceptional performance and its generally expected to continue for another 12 months and more. Which makes the AUD fall over August all the more notable. Sure, some of the AUD/USD fall reflected USD strength but cross rates like the AUD/EUR and AUD/CAD are now below their averages of the last 10 years. There appears to be plenty of expectation built in of slower Australian growth ahead and near-term RBA rate cuts. This creates the potential for a sharp AUD rebound in the next few weeks.

The extent of the rate cuts due will become clearer Tuesday. The RBA are very likely to reduce the cash rate by 0.25% but will also have to hint at another imminent 0.25% rate cut to satisfy market anticipations. As always the future is unknown but the bigger reaction is likely to come if the RBA disappoint. An AUD rebound would push the NZD/AUD lower and drag the NZD higher against other currencies.

Meanwhile the USD has stalled, albeit rates still moving through wide ranges. The volatility implies it is still worthwhile placing sell orders for the NZD around 1-2% above current levels.