By Roger J Kerr*
The Kiwi dollar was smashed lower on foreign exchange markets last week in a classic “one-two” series of punches.
Previous support for the NZ dollar against the USD at just above 0.6700 crumbled, allowing a rapid depreciation to 0.6580 at the time of writing.
The first hit came from a surprise to the markets in the form of the Reserve Bank of New Zealand (RBNZ) being outrightly more dovish on the monetary policy and economic outlook than what was generally expected beforehand.
The FX markets were badly caught off guard and not prepared for any change of tact from the RBNZ in last Thursday’s Monetary Policy Statement.
Hence, the knee-jerk and negative reaction to being surprised.
The RBNZ did not change official interest rates, however they effectively loosened monetary conditions by extending their timeline on when they anticipate making the first interest rate increase from early 2020 to much later in 2020.
The FX market’s reaction was to immediately sell the Kiwi dollar as the RBNZ (intentionally or unintentionally) signaled a loosening of monetary policy through a lower currency value.
The second hit came from global financial and investment markets being spooked by new developments in the financial crisis in Turkey.
The Turkish Lira plummeted 20% against the USD on Friday 10 August following the implementation of special tariffs on Turkey by US President Donald Trump, in retaliation to the Turks going with a Russian air defence system.
The markets feared more widespread contagion and systemic risks emanating from the economic chaos in Turkey.
The Euro exchange rate was sold heavily against the USD as well, as the currency markets feared European banks being exposed to the sliding Turkish economy.
The EUR/USD exchange rate sliced through a key support area over recent months at $1.1500 and traded lower to $1.1400. The increase of the Turkey related geo-political risk, coupled with the US/Chinese trade wars impacting on the Chinese economy, caused an appreciation of the US dollar against all major currencies.
However, it would be an exaggeration to describe the financial/economic crisis in Turkey as akin to the Greek debt crisis of six years ago.
Only a very small number of Spanish, French and Italian banks have material loan exposures to Turkey and the Turkish economy is not that pivotal in terms of regional trade and investment flows.
Therefore, the impact on global markets should, on reflection, prove to be relatively minor. The markets appear to have over-reacted to the Turkish situation, but it does demonstrate just how skittish many investors are currently.
Rising US interest rates over the last 12 months have been a challenge for many emerging markets economies who have US dollar denominated debt. The debt servicing and repayment is made tougher by their currencies falling against the USD. The Turks have so far refused to increase their own interest rates to halt the plunge in the Turkish Lira, however they will inevitably be forced to do just that.
My view is that the Euro should recover quite quickly against the USD in global FX markets and that should prevent any further depreciation of the Kiwi dollar.
Whilst the Kiwi dollar has dropped (contrary to my expectations) due to the two recent developments discussed above, further and permanent weakness is unlikely for the following reasons: –
The Kiwi dollar has taken a short-term knockdown; however, it is far from being out for the count.
With commodity prices so high it is hard to see business confidence falling further. GDP growth may not be 4% anymore, however 2% expansion is a long way from the economy going backwards.
Exporters selling in USD’s have enjoyed an eight-cent windfall gain from 0.7400 to 0.6600 over recent months.
They would be risking their future profits unnecessarily if they were not adding significant long-term currency hedging at these levels.
*Roger J Kerr is an independent treasury Management advisor. He has written commentaries on the NZ Dollar since 1981.