fxmatters

The pivotal events in the next few weeks will be whether further signs emerge of a second half global recovery (albeit probably a weak and choppy recovery). There are some signs amongst leading indicators but confirmation will be sought in the next few weeks before the collective sigh of relief goes out. One key statistic this week with high impact potential is the US ISM Manufacturing survey due Wednesday night. Any hint of a turnaround could reignite the global risk-buying wave that petered out last week.

The most probable scenario is that recovery signs will be patchy and slow to emerge, and hence the USD broad sideways pattern may persist for a few weeks yet (NZD/USD approximately 50-60c).

But the risks have changed. The eventual breakout looks more likely now to be a higher NZD/USD. Three recent changes are noteworthy:

• there has been the strong bounce of equity markets, feeding through in particular as support for the previously weak South Korean won (KRW/USD +14% in 3 weeks), as well as for the NZD.
• there is the interdependent buying of commodities (Oil +15%) and investment flows into commodity-producing countries (as reported by major funds custodian State Street).
• local interest rates are up, especially relative to the US (expected Dec 90-day rates wider by 0.75% in NZ over 3 weeks and by 0.72% in Australia).

In short, there is renewed interest in the NZD and AUD. It may be reignited this week should news emerge of a turnaround in global fortunes. It may emerge next week once the next RBA rate cut is out of the way. Or it may be that we have to wait until later. But a rally is likely in the next few months.

PS. there will be plenty of interest Thursday night but the ECB press conference is likely to be more influential than the G20 leaders’ brief London meeting.

The standout trend at present remains volatility, not necessarily any one currency direction. The NZD/USD jump of 6.4% last week resulted from the sharpest weekly drop in the USD since 1985, in turn the response to the US Fed’s commitment to continued “quantitative easing“. Unfortunately Japan is already doing likewise and Europe may yet go down that path also, so the US policy announcement need not be a harbinger of a widespread exit from USD to either JPY or EUR (the other two major currencies).

At this stage, the best that can be said is that the USD remains within a very broad, sideways pattern that could easily take the NZD/USD to 60c again, and then back to 50c once more.

Any immediate NZD rally may seem perverse when a 1% (or more) drop in NZ December quarter GDP will be announced Friday (see Calendar) but even a drop of this magnitude is less than that experienced in the UK, EU and US and pales beside the recent experiences of some Asian economies. In other words, the NZ situation is tough but it is worse elsewhere.

As always, there are forces pulling in different directions. The higher local interest rates (see Futures) and NZD exchange rates since the 12-Mar Monetary Policy Statement may elicit another easing by the RBNZ 30-Apr. The RBA are very likely to lower their cash rate 7-Apr. These forces will tend to push the NZD/AUD higher near-term but more generally push the NZD downwards in the next few weeks. But these pressures will be secondary to the USD trend. The key driving forces for currencies remain international.

The change of mood argument I put forward a month ago has proven both right and wrong. It was clearly wrong about share prices. The equity rally at the time proved to be the classic false dawn that was followed by even more panic selling. If you fancy your chances of picking the US share market bottom – and hence the NZX bottom – you may find these articles of help:

• a tongue-in-cheek list of what has to happened first;
• a suggestion that the S&P500 Index would need to fall to around 400-500 using an approach of Benjamin Graham (the ‘father’ of value-investing);
• and an earlier article of a similar ilk, warning a single-digit P/E when using more realistic forward earnings implied a bottom around 450-500.

Where I was right, though, was that currencies are now moving differently. The currency carry-trades, such as the NZD/JPY, have broken the pattern of the previous five months and have not depreciated. In fact the NZD generally appreciated last week while the S&P500 dropped 7%. What is happening is that the major currencies have stalled. The trading patterns are broadly sideways. That will undoubtedly not last. I still put more probability on the eventual break of pattern being a weaker USD (and hence stronger NZD).

Meanwhile the key near-term factor is the RBNZ policy announcement tomorrow (Thur 9am NZ time). The RBNZ will drop the cash rate again. The market is pricing between a 0.5% and 0.75% cut. A 50 point cut appears the more likely to me. There has been a tendency for currencies to stabilise/rally after rate cuts recently (although the GBP is one exception) so it would not be surprising to see the NZD rally a little over the next week or two.