Whether you believe that the moneymarkets and/or the RBNZ will be forced to alter their current view on the timing of OCR increases this year comes down to how well the economy performs in the first half of 2011. Current media and economist commentary on the economy remains pretty gloomy, focusing on static retail and housing sectors over the second half of 2010 as the key drivers of the economy in 2011. It is off course very easy to look back at the flat 2010 economy and conclude that nothing is happening any different this year to change that benign outlook. Such a conclusion runs the risk of being horribly inaccurate in my view. 

On the assumption that the NZD/USD exchange rate comes back to the 0.7000 area to help the profitability/investment of the big primary industry exporters, the economy is poised for much more robust growth this year. The September 2010 quarter GDP was negative because dairy and meat production was down due to climatic factors. Both could easily bounce back upwards in the December quarter. Manufacturing definitely improved in the December quarter and recent retail/employment data does not suggest we are not in for another shock negative GDP number when the December quarter figures come out in late March. 

I see the mood steadily improving over coming months as the 2011 data prints stronger. With the improved sentiment will come rising one to three year swap rates as the interest rate market starts to realise that 3.00% annual GDP growth does bring with it inflation risks. If the RBNZ are managing monetary policy on a 12-18 months forward look basis (as they must be) they will not be able to hold the current complacent approach too far into the year. The double-dip recession advocates are completely ignoring the main driver of the economy – agriculture commodity prices, which are at 30-year highs.

Here’s why I see the 2011 economic data improving:- 

• Another milksolids payout lift from Fonterra will encourage some spending in the provinces as the debt reduction phase runs down. 

• Increasing dairy farm land values have now repaired farm balance sheets and the bankers will be calling off their hounds if they want to maintain/grow their lending levels in 2011. 

• Rural confidence surveys are up with the fantastic prices and more certainty around winter feed stocks and grass growth (thanks to the summer rain). 

• Business and consumer confidence surveys displaying positive sentiment cannot be wrong two years in a row!

Job security and thus household spending decisions will lift with the more upbeat economic numbers coming through. 

• Outside the RWC and Canterbury earthquake rebuild the forward bookings for tourism look much stronger this year. 

• New business investment is starting to increase with business/commercial credit from the banks increasing in December for the first time in nearly three years. 

• The residential property market is no longer a lead indicator for the economy, thus irrelevant to any discussion on what will be driving the economy in 2011.

NEW ZEALAND DOLLAR MARKET COMMENTARY

USD global movements and commodity prices remain critical for NZD/USD rate

Having pulled-back from highs of 0.7800 to 0.7600 currently, the NZD/USD exchange rate does appear more prone to further decreases on the back of expected future Euro and Australian dollar movements. Local NZ economic developments continue to have little impact on the NZD value against the USD, the day-to-day market movements instead being the result of changes in the USD value, the other side of the NZD/USD currency equation. 

Economic and financial/commodity market developments are however key for the pricing of the AUD against the USD, which the NZD closely follows 90% of the time. The AUD/USD rate has again recoiled downwards after its fourth foray above 1.0000 (parity) to the USD. There is no question that the positives for the AUD that pushed the currency up from 0.8000 to 1.0000 last year are not so dominant or intense this year. Australian interest rates were increased reasonably aggressively last year by the RBA and they are now on hold with stable rates forecast for 2011. Global investment funds re-weighted hefty volumes of their money to emerging markets and commodity producers (such as Australia) in 2010 and will be more interested in cementing-in their gains than buying more in 2011. Metal and mining commodity prices continue to increase in the global markets underpinning the AUD value. However, as the USD currency improves and US market interest rates move upwards, you have to wonder for how much longer the commodity prices can keep their upward momentum without some downward correction?

Adding to the risk in commodity markets is the continuing tightening of monetary policy in China. The Chinese increased interest rates again last week as they seek to control 5% plus inflation and are prepared to sacrifice some GDP growth to achieve that objective. Just a marginal slowdown in demand out of China should bring commodity prices off. The Australian dollar in always vulnerable to falling commodity prices, however so far to date, we have not seen any adverse reaction in the commodity markets to the Chinese monetary tightening. Maybe it is still to manifest through in terms of tighter and more costly bank credit in China slowing up demand for raw materials (coal, iron ore, copper etc) for infrastructure building. 

What is becoming apparent is that international currency traders and investors are seemingly reluctant to buy and hold AUD’s at entry rates well above 1.0000. The Queensland floods will take 0.50% off their GDP growth this year and some fret about their residential property market overheating. The view is still held that the next five cent change in the AUD/USD rate will be to 0.9500, not 1.0050. Where the AUD goes, the NZD will follow until such time as the RBNZ start to lift rates here later in the year. 

The EUR/USD continues to correct back down from highs of $1.3800 to $1.3500 at the time of writing. The US economic data is now consistently stronger across the Board with rising US 10-year Treasury bond yields signifying the expectation of higher future inflation from stronger GDP growth this year. The economic situation in Europe remains confusing and perplexing with positive German growth, rising food/energy price inflation, however still major economic and financial challenges in the southern EU member-states. The Euro strengthened to $1.3800 in January following musings from ECB head Trichet that increasing inflationary pressures may cause an earlier lift in Euro interest rates.

The economic conditions and outlook in Europe certainly do not justify any interest rate increase this year and the ECB should be “looking through” and not reacting to non-controllable increases in food and energy prices in terms of their impact on the inflation rate. German Bundesbank chief Axel Weber (a hard-line inflation hawk) has resigned after clearly not being wanted for the top ECB job. On economic fundamentals alone the USD looks a far superior bet this year than the Euro. A return to $1.3000 and below in the EUR/USD rate should bring the Kiwi down towards 0.7000 over coming weeks/months. 

The local moneymarkets have shifted the timing of NZ interest rate increases to the later September/October period. When the headlines of the RBNZ “tightening” monetary policy (i.e. removing the March 2009 emergency stimulus) hit global newswires later in the year, the NZD could be expected to appreciate again on its own account. At that time the NZD/AUD cross-rate should break out of the established 0.7500 to 0.7800 trading range and move higher to above 0.8000. 

USD looking positive on the charts

The overall value of the US dollar against all currencies is measured by the USD Index. Since the credit crunch hit the markets in 2008 the USD has experienced two up moves and two down moves, as the charts below confirms. 

-       UP: Initial USD strength in 2008 as global investment funds rushed to the safe and security of the greenback when the sub-prime mortgage debacle was in full swing (USD Index up from 72 to 88).

-       DOWN: USD weakness during 2009 when the Fed slashed US interest rates and Lehman’s fell over (USD Index reversing to 75).

-       UP: USD strength through the first half of 2010 as the European sovereign debt crisis (Greece) forced disinvestment out of the Euro back into the USD’s (USD Index up from 75 to 88).

-       DOWN: Poor US economic data through the middle part of 2010 culminating in the Fed’s “Quantitative Easing 2” – printing USD’s, thus increasing the supply. The USD was sold down on the expectation ahead of that monetary easing (US Index back down to 76). 

Next USD movement?: Each low-point in the USD Index has been higher than the previous low since 2008. The up-trend support line has held firm at 76 over recent weeks and the USD looks destined to move higher on the back of stronger US economic figures.