What’s going down with the NZ dollar?

In recent weeks and months, the NZ dollar has weakened against many of our trading partners.

It’s doing exactly what you’d expect it to against a shifting economic backdrop and widening interest rate differentials between ourselves and other countries.

However, whether these moves are good or bad depends on your perspective.

The trade-weighted index, which measures our currency against a basket of others, is down more than four per cent over the last month.

It ended last week at levels we haven’t seen since March 2011.

The exchange rate that gets all the attention is the one against the US dollar, and at just under US$0.57 we’re some way below the long-term average of US$0.66.

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The NZ dollar is also sitting close to a 13-year low of A$0.80 against the Australian dollar, while it’s more than ten per cent below its long-term average against the euro.

The one major currency we’ve been strong against in recent years has been the Japanese yen, but it’s staged a bit of a recovery lately too.

We’re still well above the long-term against the yen, but the NZ dollar has slipped back from the record high it reached two years ago.

Currency markets are where the growth outlook, inflation expectations and interest rate differentials all intersect.

Right now, New Zealand is in a tougher spot than some others.

Our economy has been sluggish and while the Reserve Bank has lifted interest rates, the OCR is still below many of its offshore counterparts.

That’s unusual, as our interest rates have typically been higher than other regions over the past few decades.

Until this year, our OCR had spent 70 per cent of this century higher than the Australian cash rate.

Today we’re at 2.75 per cent and they’re at 4.60 per cent, a gap we’ve only seen the magnitude of once before, in the 2010 to 2012 period.

This makes us a less attractive proposition for global capital, so money chooses to go elsewhere.

Sentiment has also become more cautious as geopolitical tensions rise, the conflict in the Middle East escalates and the list of things to worry about lengthens.

It’s not all bad.

A weaker NZ dollar is an important shock absorber for us, and it can be a very effective one.

It’s a tailwind for the export sector, making us more competitive internationally and pushing up the value we get for goods sold overseas.

As well as the farming sector, tourism is another industry that benefits from a weaker currency, because we become a more affordable holiday destination.

Australia is one of our most important markets for international arrivals, and we look much more enticing approaching A$0.80 than we did at A$0.93 in the middle of last year.

Inflation is the other side of the weaker currency coin.

A lower NZ dollar leads to higher prices for imported goods, including fuel, raw materials and everything else we source from offshore.

That added pressure can encourage the Reserve Bank to raise interest rates, which might close the gap between our policy rate and others, supporting the NZ dollar and keeping future imported inflation at bay.

Investors need to be mindful of currency moves too.

Sometimes these moves work in your favour, like they have recently.

The S&P 500 index in the US is close to flat in September, but a weaker NZ dollar has boosted that return to almost five per cent.

It’s also meant that a small year-to-date decline in the Australian ASX 200 index magically turns into a six per cent gain when currency moves are accounted for.

That won’t always be the case.

There have been plenty of times where currency moves have proved a headwind or even turned positive returns into negative ones.

Right now, we’re about five per cent below the long-term average on a trade-weighted basis.

If things revert toward the average over the coming years, that’ll be a headwind for international shares.

This is something to be mindful of, but currency moves shouldn’t drive our decisions.

It’s more important for share investors to focus on great businesses with good prospects, wherever they happen to be.

Many local investors are happy to take on some currency risk, and the best way to think about this is to consider it an insurance policy against our small, vulnerable economy.

However, if that worries you or if you dislike the idea of something else to try and predict, hedging the currency is an option.

Professional investors and those with large portfolios often do this, to varying degrees, and there are many funds and ETFs that make it easily achievable.

The same goes for business owners, who can only do their best to manage currency risks.

There’s no perfect level for the NZ dollar.

Ideally, we want it low enough to keep our exporters competitive, but strong enough to maintain our purchasing power in the global marketplace.

A weaker currency is a double-edged sword, and the sweet spot is arguably a little higher than where we are right now.

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