fxmatters

There have been some atypical movements in currency markets in the last week or so but at the end of the day the global recovery story continues, share prices are still pushing higher and the central banks around the world are loathe to act, suggesting the current upward NZD/USD momentum is not over yet.

There have been murmurs of disquiet with a low USD, and hence high EUR and JPY as well as high NZD, but there appears no concrete action imminent.

Meanwhile stronger NZ economic statistics – including probably business confidence released Wednesday – and talk of a near-term RBA tightening suggest the local currencies remain to the fore of any rally against a weak USD.

The NZD remains caught up in global forces. Last week the NZD generally weakened, falling against 30 of 38 monitored currencies but it was the gain against the weakening USD (and GBP) that received most attention. Over 4 weeks the NZD has appreciated against 34 of these currencies with one of the exceptions being the AUD. In other words, the RBNZ has not managed to disentangle the NZD from the weak USD on the one hand and the strong AUD on the other. There is the possibility that the release of NZ June quarter GDP Thursday (see Calendar) may shake the NZD free a little but more likely the fate of the NZD will rest with the major global trends.

Here the key tension is mounting evidence of global improvement and a reticence by central banks to respond for fear of derailing the nascent recovery. This is creating an abundance of US dollars and a goldilocks period for risky assets, especially when priced in USD. This period cannot last and the question is when the (relatively) little bubble is pricked. Ten years ago the answer was more likely later rather than sooner, the attitude being any remaining problems can be patched up afterwards. The recent experience of the financial crisis suggests central bankers should not allow bubble-like conditions to persist. Already there is tightening occurring outside the largest economies Bloomberg.

One example of the imbalances that the current policy settings cause is the Chinese yuan. It could be argued that a weaker USD is appropriate given global conditions but the USD is not just the USD – it is also the Chinese yuan (and the Hong Kong dollar) as the yuan is very closely linked to the USD at present. The end result is the EUR/CNY has now moved above the long-run average and there will be increasing calls within Europe for either a lower EUR or a higher CNY.

It is unlikely that the meeting of G20 leaders Thursday/Friday will provide a reaction plan, nor the US Fed meeting Wednesday (Thur 6:15am NZ time). But market players will increasingly focus on exit strategies (i.e. tighter monetary policy) in the next few weeks.

In terms of the NZD/USD, the momentum remains upward but the risk of a sharp turnaround is high.

Any post-MPS NZD selling was brief and more than offset by subsequent buying. In fact the NZD was one of the strongest currencies in the world last week (slightly behind the Russian ruble), posting the ninth consecutive weekly NZD/USD gain. It is apparent that the RBNZ are reluctant to respond to the stronger NZD, conceding they believe there is little they can do to influence the NZD – the result was the NZD/AUD rising 1.5% over the rest of the week.

However, the NZD/AUD remains within the upper half of an approximate 77-83c range. It is likely to remain within this range, including moving below 80c once market participants return to focusing on the probable gap between any RBA and RBNZ tightening (i.e. the RBA moving much sooner than the RBNZ).

Meanwhile the NZD/USD strength rests on a weak USD and strong share markets. There are global forces that could reverse both or each of these trends quickly. A bias towards selling the NZD at these levels appears appropriate but that is not to say the NZD/USD could not rise further in the short-term.

Movements in financial markets went against the usual patterns last week – AUD, GBP, NZD up but so too the JPY, all happening while share and oil prices declined. Significantly another wave of Chinese share market weakness failed to spark wider large-scale selling.

There are many questions about sustainability of current share prices (and an upward trend) but global economic news keeps showing up evidence of improvement. Locally the signs of improvement for August include NZ housing activity again up judging by Barfoot’s Auckland sales, likewise dairy prices, while retail sales failed to kick ahead but are improved on first half 2009 judging by Paymark electronic transactions.

Policy makers are taking a cautious approach to the global green shoots, generally adopting a no-tightening-soon approach. Significantly the RBA passed up the opportunity last week to warn of tightening ahead, although their comments were non-committal. Over the weekend, the G20 said “fiscal and monetary policy would stay expansionary as long as needed to ensure recovery”. The danger with this approach is that it sets up a greater knee-jerk reaction some months ahead – the eventual tightening will remain a market focus.

In the meantime, the Reserve Bank of New Zealand are likely to take this offshore lead by central banks and, consistent with their own earlier comments, play down the likelihood of near-term interest rate hikes when presenting the Monetary Policy Statement Thursday 9am. They may even go so far as to drop the cash rate by 0.25% to 2.25% p.a.

These present mixed forces for currency markets: the delay to the inevitable global tightening and the current growth momentum imply a rising NZD; the prospect of a dovish RBNZ and current nervousness about global share prices imply ample downside risks as well. A prudent approach would be to put more weight on the RBNZ this week and sell NZD ahead of Thursday.