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Falling Dairy Trade Auction Prices Test NZDUSD

Published 12/03/2014, 12:46 AM
Updated 03/19/2019, 04:00 AM
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The commodity currencies – the Australian, Canadian and New Zealand dollars – have been struggling over recent weeks as commodity prices across the board come under pressure. For New Zealand, it’s food prices that matter, dairy in particular, given it is the country’s biggest export earner.

The latest Global Dairy Trade auction (yesterday) was therefore on the radar of NZDUSD traders. Despite an expectation – or perhaps hope – for some sort of relief from the 50% fall so far this year, the average auction price was down another 1.1%.

In response, NZDUSD slipped 50 pips to be trading just on 78 cents now, firmly back in its two month trading range. The next domestic test for the Kiwi will come in the December 11 monetary policy statement and forecasts from the Reserve Bank of New Zealand, but before then US payrolls data on Friday is a hurdle to be cleared. The chart below shows an index of commodity prices important to New Zealand, weighted by the contribution to exports. Dairy products comprise almost half the index and with those prices down by half since February, this has triggered a sharp downturn in the chart.

However, stronger returns for meat and seafood has restricted the overall decline in the world price index to 16% over the last year. More important, a fall in NZDUSD in recent months means that fall in NZ dollar terms has been only half that.
ANZ commodity price index
bank From a longer term perspective, the chart shows an extraordinary run up in New Zealand’s food export prices over the past decade or so, and it is no coincidence this has been matched by an equally impressive rally in the exchange rate, as shown in the chart below.

However, the large scale of the chart obscures the fact that the Trade-weighted-Index (also known as the effective exchange rate) has only come off its record high by about 4% – less than half the fall seen in commodity prices.

New Zealand dollar exchange rate
NZ real effective exchange rate

Stubbornly high currency

The failure of the exchange rate to adjust sufficiently to commodity price falls puts New Zealand in the same boat as Australia (just substitute “iron ore” prices for dairy in the discussion above). And the reason for the stubbornly high exchange rates is similar in both cases: although the headline cross versus the US dollar has fallen noticeably, unco-operative behaviour in the non-US dollar cross rates has to a large extent cancelled this out.

In New Zealand’s case, the NZDJPY, which has a 15% weighting in the TWI, is close to a 40 year high and the NZDEUR and NZDGBP remain in multi-year uptrends. A further hindrance – given its 22% index weight – is the NZDAUD, which has bounced strongly over the last few weeks. This all adds up to the RBNZ declaring the New Zealand

dollar still being at an “unjustified and unsustainable level”.
That may well be the case in the medium to long term, but in the meantime the search-for-yield story holds centre stage in the FX markets, and in that respect New Zealand is the lead actor. The policy interest rate stands at 3.50%, having jumped 100 basis points from the level shared with Australia at the beginning of the year, and market pricing suggests there is more to come in the next couple of years, albeit at a slower pace than expected a couple of months ago.

The following chart shows expected short term interest rates for the US, the UK, the Eurozone, Australia and New Zealand based on Overnight Interest Rate swap pricing and Federal Funds futures. On this basis, there is little prospect of much downside in the non-US dollar crosses in coming months, which means the NZDUSD will need to more heavy lifting if the TWI is fall significantly. With commodities priced in US dollars, that might happen if dairy prices were to slump more over coming weeks. But that is an unknown.

As for the technical picture for the NZDUSD, the sideways pattern continues and attempts to rally have been contained by the 55 day moving average (click the chart below to enlarge). We would need to see a close above that resistance level to justify opening a fresh long position.

Short-term interest rate expectations
Cross country market expectations
As for the technical picture for the NZDUSD, the sideways pattern continues and attempts to rally have been contained by the 55 day moving average (click the chart below to enlarge).

We would need to see a close above that resistance level to justify opening a fresh long position.

NZDUSD trend
NZDUSD daily chart

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