fxmatters

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.