The New Zealand dollar was the best performer among the most highly traded currencies today after another strong rise in prices at the fortnightly Global Dairy Trade auction. NZDUSD rose from 0.63 before the auction result to be trading around 0.6360 when the Asian trading session opened.
Attention now turns to tomorrow’s local GDP number, before the all-important Federal Open Market Committee meeting Friday morning (NZ time).
The dairy price index rose 16% at last night’s auction, a bit higher than futures prices had predicted. Whole milk power for November delivery jumped 26%. This is the third positive auction result in a row, and with NZDUSD holding steady throughout, dairy prices in NZD terms have recovered smartly from multi-year lows, as shown in the chart below.
However, there is still a long way to go before local farmers can breathe a sigh of relief. Also, the market has rallied largely due to reduced volumes on offer, a situation that may not last, as US and European Union production is rising and needs to find a home because the previous buyer, Russia, continues to impose a ban on EU dairy imports.
Source: Bank of New Zealand
For the New Zealand economy, the rally in dairy prices comes at an opportune time as the big fall over the past 12 months has hit national income and business confidence. The Reserve Bank of New Zealand has responded with interest rate cuts and jawboning on the exchange rate, reinforcing both in its Monetary Policy Statement (MPS) last week.
However, some economists think the bank might be overestimating the effect falling dairy prices are having on the country’s terms of trade. As this chart shows, the latest MPS showed a big decline in the expected path of the terms of trade compared with the previous MPS in June.
In contrast, economists at the ANZ Bank are more positive, especially as the oil price looks likely to remain under pressure.
Source: ANZ Bank
But despite the improvement in dairy prices, financial markets continue to price in at least one more cut to the RBNZ’s official cash rate (OCR). Traders seem to agree with the bank’s assessment that economic growth is slowing to an annual rate of around 2% while domestic inflationary pressures remain subdued.
In these circumstances, the exchange rate needs to at least stay down at current levels, and preferably fall further, to ensure a pass-through from higher import prices into the consumer price index and take it up to the 2% target level.
Taking everything into account, the money market is pricing the OCR at 2.41% by April next year, which implies a good chance of two more cuts off today’s 2.75%. Traders who think the economic outlook is brighter than that can pay the April fixed rate at 2.41% and receive the floating rate through until then and pocket the difference if their view turns out to be correct.
Alternatively, of course, they can buy NZDUSD.
Source: Westpac
Tomorrow’s second-quarter GDP number will have some impact on market pricing – including NZDUSD – even though it is old data. That’s because expectations are in an unusually wide range of 0.3% to 0.9%. At the lower end of the scale this would take the year-on-year rate of increase down to 2.3% and confirm the economy is in for a soft patch.
Source: ANZ Bank
With the local data out of the way, the deck will be cleared for the week’s big event to set the direction for NZDUSD. FOMC members have been talking the talk via the “dot” projections for the federal funds rate but the market continues to doubt they will walk the walk on Thursday.
This chart shows the dots from the last set of projections issued in June compared with current market pricing.
Source: ANZ Bank
A strong rally in dairy prices over recent weeks has taken some of the pressure off NZDUSD. However, a slowing economy and subdued inflation suggest further easing of monetary policy is likely. However, both these influences on the kiwi dollar will take second place to the FOMC decision on Thursday.
My technical analysis (Elliott Wave) of NZDUSD is presented below. If you would like more
detailed trading advice then let me know.
NZDUSD weekly chart (click to expand)
Source: ThomsonReuters
NZDUSD daily chart (click to expand)
Source: TradingFloor