fxmatters

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.

Waves of anxiety are driving financial markets at present. This has little to do with rational analysis (but then the same could be said when waves of optimism were the driving force in earlier years). Each wave of fear at present produces falling share prices, lower commodity prices and, leading the currency charge, a lower AUD. The net effect was another sharp NZD fall last week, except against the AUD (the NZD/AUD rising 8% Saturday to Saturday to over 92c before slipping this morning).

Quite staggering, the NZD/USD has depreciated 22% since 18-July, and the NZD/JPY 26%. The NZD/AUD increased 18%.

At times like this it is important to resist the urge to foresee the future in black and white terms. There are undoubtedly parallels with history but there are many things that are also different. It is prudent to think in terms of global recession or maybe a couple of quick recessionary bouts but a repeat of the depression years still appears only a remote prospect. Credit growth and general asset price appreciation will be much less in the next 5-10 years but rising incomes will likely still produce an upward bias to both in the medium term. Australia in particular appears well placed to weather any global recession and hence insulate New Zealand to a large extent. These thoughts suggest a strategy of tentative equity buying.

As regards currency, the NZ dollar is now close to the long-term average on a TWI basis. History has shown it could be significantly higher or lower in a couple of years time and one should not be too confident about a view in either direction. In the meantime, further waves of fear could emerge and drive the AUD and NZD lower. But there is also the strong prospect of a sharp rebound soon. Picking the timing of these events is nigh on impossible so a strategy of exporters accumulating NZDs over the next few days and weeks, and having orders in below current levels appears prudent. Importers are more awkwardly placed as the NZD has already dropped a long way – except, that is, against the AUD where a similar strategy of selling NZD/AUD now and having orders above 90c appeals as a strategy.

The key message: have a strategy; it is not time to be whimsical.

(PS my apologies to those who received an old posting by email on Friday. A problem with the host server resulted in the website reverting to a backup copy and in the process the old email was triggered).

The period of USD weakness proved brief and ended last week with devastating effect: a 5.8% EUR/USD fall (i.e. USD rise), and many double-digit commodity price falls including oil down 12%. The likelihood of slow global growth is increasing with each bout of banking difficulty. The net effect was a lower NZD against the USD and JPY (and most Asian currencies) but a higher NZD against most European currencies and against the AUD.

It is these later moves that appear the anomalies. Confidence has ticked up in NZ following the RBNZ easings of July and September – as likely to be released this week – but the global meltdown will impact here, and will also drive local interest rates even lower. In the meanwhile the global turmoil has added 1.25% p.a. to NZ banks’ short-term funding costs offshore in the last 4 weeks, and has dried up funding for some non-banks. The RBNZ will be even keener now to ease again soon.

These local factors imply a downward trending NZD in the next few months, and probably in the days ahead of the 23 October OCR Review. The offshore factors will add volatility. The week ahead is likely to be relatively calm compared with the extreme volatility of last week with probably some reversal of the major moves of last week.