New Zealand dollar slumps again on dairy trade auction price drop

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Last night’s global dairy price auction was another kick in the guts for the NZD, causing NZDUSD to drop almost 100 basis points. It was only saved from a more precipitous decline by disappointing economic data from the US which weighed on the USD side of the cross.
New Zealand is the world’s biggest dairy products trader and dairy makes up a third of the country’s merchandise exports. But most of the product is a simple commodity – whole milk powder – largely aimed at the Chinese market, where it is processed and the value added. Thus, New Zealand is a price taker in what can be a volatile global marketplace.
In this latest auction, prices fell 7.2% and have now almost halved since the peak in February. That’s some move. The key whole milk powder price fell more than 9%. Increased supply from domestic producers is adding to a European surplus that has resulted from sanctions on dairy imports imposed by Russia.
Commodity price falls of this magnitude, if sustained, could damage New Zealand’s rosy economic outlook.
Just as in most commodities, dairy products are traded in USD, so there is some consolation in that in NZD terms, prices are only down 2.4% on the September 4 auction because of the sell-off in NZDUSD in between.
Central bank intervention is starting to pay off
The dairy price collapse adds weight to the strident calls being made by the Reserve Bank of New Zealand that the exchange rate needs to decline. If the markets don’t listen, they are prepared to start the ball rolling themselves. Indeed, they have already done so.
On Monday, the RBNZ released details of its currency transactions for August and they showed sales of a bit over NZD500 million. This intervention had been justified a few days earlier in an unexpected statement from RBNZ Governor Graeme Wheeler, where he left no doubt he would walk-the-walk when it came to dealing with an exchange rate he considered to be at an “unjustified and unsustainable” level.
It looks as if the RBNZ may have been a seller in September also, but we won’t have that confirmed until the October 30 statistics are released. While NZD500 million over a month is not significant when the daily volume in the Kiwi dollar is 2 billion, it does show resolve.
The RBNZ was given authority to intervene in the currency market by the Minister of Finance in the mid-2000s, and it has used it sparingly, but successfully, as demonstrated in this chart. Sales in 2007/2008 helped knock the Kiwi off its perch and taxpayers were rewarded when the short sales were covered at a nice profit in 2009-10.
Exchange rate decline has much further to run
Like all central banks, when assessing the value of the exchange rate, the RBNZ does not just watch a single cross rate, such as NZDUSD, but uses a weighted average of all the cross rates New Zealand exporters do business in.
This is referred to as the effective exchange rate, or sometimes the trade-weighted-index. This index is further adjusted to reflect relative inflation rates, because if the costs of production are rising at a faster pace than in the global marketplace, a country loses competitiveness.
The result is the real effective exchange rate.
The NZD was floated in 1984 following a 20% one-off devaluation. The regression line on the chart is drawn from that point.
As the chart shows, it is no wonder the RBNZ has been sounding the alarm for the past couple of months. The exchange rate had continued rising, despite commodity prices rolling over. No doubt carry traders were behind this, failing to see the wood for the trees. They’ve been given a wake-up call in the last couple of weeks.
There are two ways a country’s real effective exchange rate can decline. The first is if inflation – and thus costs of production – is lower than that of its global competitors. New Zealand was a world leader is setting inflation targets, but even at 2%, inflation has been running at a higher level than Europe, Japan and the United States.
So that means, to maintain or improve competitiveness, the nominal exchange rate has to fall. That can be via any of New Zealand’s key trading partner crosses: NZDUSD, NZDAUD, NZDCNY, NZDJPy, NZDEUR, or a combination.
Reserve Bank wants a lower exchange rate and higher interest rates
New Zealand’s economic outlook still looks good, even with commodity prices coming off. Indeed, it is growing faster than capacity at the moment (a positive output gap). In response, after four years of loose monetary conditions, the RBNZ is seeking to normalise policy settings. The official cash rate has already been raised 100 basis points to 3.5% this year and the bank estimates the neutral rate to be around 4.5%.
The trouble is, each time rates were increased, the exchange rate got another boost.
The strategy now is to break that link by refocusing the market’s attention on old-fashioned fundamentals and away from the carry trade.

Mirá También

Así lo expresó Domingo Possetto, secretario de la seccional Rafaela, quien además, afirmó que a los productores «habitualmente los ignoran los gobiernos». Además, reconoció la labor de los empresarios de las firmas locales y aseguró que están «esperanzados» con la negociación entre SanCor y Adecoagro.

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