fxmatters

This week the focus shifts to the RBNZ. Add the likelihood that the RBNZ will repeat its call for a mid 2010 tightening to the global share market rally and the RBA rate hike of last week and the scene is set for the NZD/USD to rally this week.

In broad terms the economy is evolving as the RBNZ outlined in the December Monetary Policy Statement, albeit with the upside growth risks now less. There is much to be uncertain about at present including near-term global growth prospects, the impact of local liquidity requirements for banks that come into force 1 April and the policy measures to be unveiled in the 20-May Budget. Nonetheless the local growth rate is now higher and, significantly, the Australian economy is strengthening.

Meanwhile the cash rate is at unsustainably low levels. The appropriate policy path is to continue warning of imminent cash rate hikes but allow scope for reaction to the April/May policy intitaives; hence the likelihood that the RBNZ repeats the vague “begin removing policy stimulus around the middle of 2010″ line on Thursday.

Any NZ dollar reaction this week is unlikely to change the broader picture of a sideways trading NZD/USD with the probability of a revisit to 65c still high.

One of the largest risks this year is of further credit-related issues. It is this factor that will likely see the NZD/USD revisit 65c in the next few months.

However we are also amidst a large mining boom in Australia, in turn the result of strong emerging economy growth – as discussed by the RBA last week [speech]. Of particular interest is the RBA’s expectation of higher terms of trade to come for Australia [given earlier in the month]. This would normally mean an upward bias to the Australian dollar.

History suggests that the risk cycle will win out in the short-term (i.e. over days/weeks) but, short of the major reversal in China, that the mining boom will probably dictate the AUD trend over the next 2-3 years.

One of the ways that these mixed influences have manifested recently is to push the AUD/EUR towards highs even while the AUD/USD has been slipping lower.

A similar pattern is noticeable with the NZD. The NZD/EUR does swing with shifts in the USD but the medium-term drift is upward (due largely to the AUD influence). Looking forward, the expected USD rally will likely see the NZD/EUR lower in the next few months but new highs for this cross-rate are still probable later this year.

After dealing to a heavy workload and a hacker, the regular fxmatters blog is back. Besides issues to do with time management and website security, the other lessons I take from recent months/weeks are twofold.

Lesson 1. The US dollar is not on a one-way downward path (and hence the NZD/USD is not on a one-way upward path). The last few months have proven that exchange rates are in a broad sideways trading pattern. There are many problems in the US but there are many financial problems elsewhere as well.

Lesson 2. The US is likely to exit their (huge) monetary rescue package sooner than Europe. The Fed comments imply this (including Bernanke speech). The data being released imply this. It is this fundamental monetary policy pressure, as much as concerns about Greek debt, that appears behind the current USD rally.

There is no sure thing when it comes to the future but one strong starting point is the likelihood of higher long-term interest rates in the US, a combination of high debt issuance and the removal of the US Fed as a buyer (and possibly changing to a seller).

The other high-probability event is that there will be further debt problems, again a risk heightened by the private sector being left more to its own means this year.

Higher US long-term interest rates and the odd debt problem suggest a few rough spells for the US share market, and hence share markets in general, further adding to USD appeal (as a flight-to-safety).

All in all, a run down to around 65c is to be expected for the NZD/USD over the next few weeks within a broad sideways trend.