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.