Christopher Niesche: It gets knocked down, but it's up again

Currency forecasting is a mug's game. If ever there was proof of that, it's been over the past couple of months and in the past fortnight in particular.

Slowing growth and a burgeoning current account deficit should have combined to see the New Zealand dollar fall sharply this year.

But after a quick drop earlier in the year, the kiwi has ignored these economic fundamentals to rise by 10 per cent from under US60c since June. Bouncing along at around US66c last week, the kiwi has defied all expectations.

Part of the strong performance is due to our high interest rates.

Stronger-than-expected consumer spending and sky-rocketing oil prices have kept upward pressure on inflation, meaning Reserve Bank Governor Alan Bollard hasn't been able to cut interest rates and won't be able to do so for some time yet.

As a result, international investors - commonly said to be Japanese housewives and Belgian dentists - are continuing to buy up the currency because they earn much higher interest on the kiwi than they would on their yen or euro.

But there's also another force at work that has added juice to the kiwi's rise: international hedge funds.

Hedge funds are aggressive investment funds that can make short-term, highly leveraged investments for huge profits. Over the past year or so, they've taken a bet that the kiwi will fall steeply.

Indeed, at a Goldman Sachs hedge fund conference in Miami in January, participants were asked to indicate their favourite trade for the coming year with a show of hands.

Of all the investments available to them around the world, 80 per cent of the hedge funds chose a fall in the New Zealand dollar as the best trade.

The hedge funds have different ways of making money from the falling kiwi, but basically what they do is first sell New Zealand dollars they don't own.

Then, when the kiwi has fallen, they buy the currency in order to pay back what they originally sold.

The fall in the kiwi means it costs them less to do this and they pocket the difference.

However, most of the hedge funds got it wrong this year and they've been scrambling over the past couple of months to unwind their positions before they lose too much more money. This has involved buying up vast sums of kiwi to settle their debts.

Indeed, rumours swept the forex market last week of a single fund buying $3 billion worth of kiwi to unwind a trade - this compares with an average daily turnover of $1 billion.

This is what has pushed the kiwi up so steeply in the past couple of months and saw it gain 2c in the past fortnight, despite confirmation that the current account deficit isn't improving.

So where to next for the kiwi? Let's take another stab in the dark.

With little sign that interest rates are going to come down any time soon, demand for the currency should remain solid and the kiwi probably won't fall much this year.

But perhaps by the start of next year, the high interest rates and high petrol prices might have started to hit the Kiwi consumer in the hip pocket, slowing the spending binge.

This might allow Bollard to start thinking about cutting interest rates, thereby reducing international demand for the New Zealand dollar.

Also, some $4.7 billion worth of foreign-owned New Zealand dollar bonds are due to mature in the four months from December to March next year, about double the amount that matured each month this year.

When this happens, most of the foreign investors will take their money home, meaning they'll have to sell New Zealand dollars to convert them into their own currency.

This will likely drag the kiwi lower and the long-awaited fall will begin for real this time.

That's the theory anyway, but as we know, currency forecasting is a mug's game.