fxmatters

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.

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.

It seems the currency markets are evenly poised, participants worried about a reducing interest rate advantage in NZ and Australia but unexcited by opportunities offshore. The week ahead may do little to shape opinions either way with little major events scheduled.

The same cannot be said for the first two weeks of September: there is the likely RBA rate cut plus a stream of Australian data releases; there are central bank decisions and statements to come out of Europe and Canada; there are the usual early month US economic statistics; and then our own RBNZ will announce on local interest rates 11-Sep (see central bank schedule).

The two major driving forces in the next couple of weeks appear opposite.

The first is likely selling of the NZD and AUD heading into their respective cash rate cuts, the typical pattern before such announcements.

The second is the USD itself appears to have exhausted its rally and is more at risk of weakening again (hence creating upward pressure on the NZD and AUD). Interestingly this type of choppy major currency pattern has meant the fx trending models used by the world’s largest currency hedge have been of little use. The International Foreign Exchange Concepts “Developed Markets Currency” fund dropped 5% in the first seven months of 2008, leading fund head John Taylor to observe “It’s become much harder to make money on the majors … they are not totally random, but it’s damn near.” (He did very well with other currencies mind you – see Bloomberg)

The net effect is the NZD may well remain above 70c for a while yet but possibly weaken against the EUR near-term. Over the next few months, though, the case for a weaker NZD across the board remains strong given the lack of local growth and little prospect of a quick economic turnaround.

The NZD kicked the global trend last week, rising 0.2% against the USD and returning to above US$0.7 and A$0.8 in the process. As a comparison, the EUR/USD was down 2.1% and the AUD/USD down 2.5%.

The first point to note is news is still accumulating about the weak NZ economy and the anticipation of rate cuts will probably build as we move into the 11-Sep RBNZ Statement. Expect some NZD weakness early September.

What happens in between time, and in particular how high the NZD reaches, will most likely depend on international trends.

Three points suggest some caution above simply extrapolating the recent USD strength: August is a month of thin volumes as northerners holiday; the market is still increasing its pricing of risk for US banks, not a trend that encourages confidence about the US economy and hence the USD; and the rapid narrowing of the gap between European and US interest rates has stalled (and maybe ended for now).

The chance of a weaker USD suggests placing sell orders for the NZD around a couple of cents higher, say above US$0.72 and A$0.83.

Last week was not a good week for Australia, and I am not referring to Eden Park. The AUD was weakest of 38 currencies monitored here. That has not been the case in a long time. Part of issue is the recent peaking of commodity prices. More significantly the market is now focusing on the next move by the RBA being an easing (see interest rate futures), possibly as early as September (but not this week, surely?).

Now this is great news for NZ exporters – if the NZD is to reach generally low levels it will most likely require a weak AUD also. The problem is, at least as I see it, that things are not all bad across the Tasman. Confidence levels are down sharply but export prices remain extraordinarily high. The monthly Australian employment figures released this week (see calendar) are likely to show continued job growth and low unemployment. The market appears to be getting a little ahead of itself expecting the RBA to ease soon with labour markets tight and inflation above 4%. This suggests a choppy AUD in the weeks ahead, rather than a one-way fall.

The short of it for the NZD is maybe we get to see the NZD/AUD run back up towards 80c now but longer-term the NZD/AUD looks set to trend lower yet. We may also get to see the NZD/USD push towards 70c but don’t be too confident of a shift down in the 60s just yet.

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.