Nz dollar flying high again

The NZ dollar has pushed through US$0.73 against the US dollar, which sees it at its
highest level since early 2018.

This strength in our currency isn’t a great surprise, and there’s every chance it will
continue. This will have implications – both good and bad – for the economy as well as
investors.

The US dollar, like the Swiss franc and the Japanese yen, is generally considered to be
counter-cyclical.

In other words, these are the safe currencies that investors flock to when they smell
trouble, but which fall out of favour when confidence is high.

In contrast, the NZ dollar, along with its Australian counterpart, is seen as a ‘risk
currency’.

For a range of reasons, including the sensitivity of both country’s to commodity prices,
our currencies tend to fly high when people are optimistic and get sold off when
markets turn cautious.

We saw that happen last year, when the NZ dollar fell almost 20 per cent during the
most fearful period of the pandemic.

That was also the case was during the GFC. The NZ dollar was trading above US$0.81 in
the middle of 2007 and by early 2009 it had fallen to just below US$0.49, a collapse of
almost 40 per cent.

Interestingly, that saw US shares hold up better than the local market during the GFC in
NZ dollar terms, despite domestic shares proving more defensive in a local currency
sense.

Today, financial markets are in a much more upbeat mood. The vaccine programme is
well underway, investors are focused on a gradual reopening of the global economy,
and corporate earnings have begun growing again.

Not only that, but the local economy in also in very good shape. Despite the challenges
we face, we are in an enviable position compared with many other parts of the world.

Our unemployment rate is lower than most, we have more fiscal headroom to continue
supporting the economy and there are few virus-related restrictions in place.

Commodity prices also remain highly supportive, with the global dairy trade (GDT) index
having risen at the last seven consecutive auctions. It is now up 22.3 per cent since the
end of October and at its highest level since early 2014.

Dairy prices and the NZ dollar (at least against the greenback) enjoy a close
relationship, which is illustrated in the chart below.

Global dairy prices and the NZD USD

This suggests the current dynamic is unlikely to change anytime soon, and whether this is
good or bad depends on your perspective.

A higher NZ dollar means we are wealthier in a global sense, and that we have greater
buying power across international markets.

That means all the products we purchase from overseas are cheaper, including
imported components for products, most notably fuel.

This should keep downward pressure on interest rates, as it means that consumer
inflation remains subdued.

On the other hand, many exporters would prefer a lower currency, as this makes their
products more competitive and adds to returns.

For investors, a stronger NZ dollar can be a headwind for many listed exporters, such as
Fisher & Paykel Healthcare, Mainfreight or Pushpay.

Having said that, if the conditions are in place for a strong NZ dollar one would think
these companies are benefitting from the underlying economic backdrop in many ways
too.

A strong currency also has a large impact on the international holdings of domestic
share investors. As an example, if Apple shares are rising but the US dollar is falling, a
local holder of Apple wins on the one hand but loses on the other.

That certainly doesn’t mean we should be put off investing outside our shores. As an
example, 40 per cent of the revenue of companies in the S&P 500 comes from outside
the US. For the technology, materials and consumer staples sectors, the proportions are
even higher.

This means a weaker US dollar leads to higher profitability for many of these companies,
which should have a positive effect on share prices and offset the currency headwinds
for investors.

It’s difficult to predict where the currency is going over the next few years, but if markets
remain in a positive mindset and the local economy continues to perform better than
most, it could push higher.

For what it’s worth, forecasts from the local bank economists suggest the NZ dollar could
rise to US$0.75 between now and June 2022, which would see it almost three per cent
higher than current levels.

However, it should be noted that while the US dollar gets much of the attention, the
moves against other currencies haven’t been nearly as strong.

In fact, the NZ dollar has fallen 6.9 per cent from its 12-month high of A$0.9950 against
the Australian dollar, where it sat in March last year.

In contrast to the US, where the stronger currency has eroded most of the return over
the past 12 months (from 16.8 per cent to 1.1 per cent for the S&P 500 index), a
weakening NZ dollar against its Australian counterpart has added to returns from
Australian equities.

There is every chance this continues, given the better relative position of the Australian
economy, compared to many others. Like us, Australia is benefitting from strength in
commodity prices and from a robust Chinese economy.

If global growth picks up as expected, the Australian dollar could find itself in vogue with
global investors to a similar (or greater) degree than our own, which could insulate local
investors from adverse currency moves.

The NZ dollar has also declined against the British pound, while it is little changed against
the euro compared with where it was at the end of 2019, before the emergence of
COVID-19.

A strong currency certainly isn’t all bad. Investors with a long-term horizon should cheer
the prospect of getting more bang for their buck, and the ability to add more great
international businesses to portfolios while the NZ dollar is relatively strong.

For those who long for a weaker currency, it seems we can’t have our cake and eat it
too. If the outlook is positive the NZ dollar usually rises to reflect that, and if the currency
is weak, it probably goes hand in hand with a more concerning economic picture.

As investors, these are all things we need to be mindful of, although currency moves
certainly shouldn’t drive our investment decisions. It’s more important to focus on great
businesses with strong growth prospects, wherever they happen to be and whatever
currency their shares happen to be priced in.

We should also remember that should trouble emerge, the winds could change quickly.
We’ve seen that happen many a time in the past, and in those instances hedging our
bets with a bit of exposure to other currencies has paid off.