Roger J Kerr asks some pertinent questions and proffers some answers on the way ahead for the New Zealand dollar

The Kiwi dollar has been right royally side-swiped by global risk events over recent weeks, sending it lower to 0.6400 against the powerful US dollar in the forex markets. The US dollar has continued to make short-term gains as investor risk sentiment turns decidedly negative from the Federal Reserve ramping interest rates higher and the Euro and Chinese Yuan currency values continuing to weaken for their own reasons.

The economic and financial/investment market outlook is as murky as ever as participants position against an unusual combination of high inflation, slowing GDP growth and tumbling investment asset values (both bonds and equities).

Against this backdrop of future uncertainty it is again timely to ask some pertinent questions and proffer some answers for what it all means for the Kiwi dollar’s value going forward.

Q1: On how many previous occasions has the Kiwi dollar depreciated six cents against the USD in a month? (31 March 2022 NZD/USD = 0.7000)

Over recent history? Quite a few! It is not unusual for the 10th largest traded currency in the world, the Kiwi dollar, to suffer large falls from concentrated market selling in deteriorating FX market liquidity conditions.

• When the world was ending during the GFC in 2008 and commodity prices were collapsing the NZD/USD rate depreciated 30 cents from 0.8000 to 0.5000 in the space of 12 months.
• Tumbling dairy prices and a strong USD in 2015 walloped the Kiwi down 20 cents from 0.8500 to 0.6500 over a 12 month period.
• The March 2020 Covid economic shock, when the world found itself suddenly short of USD’s, resulted in the NZD/USD rate plummeting 10 cents from 0.6500 to 0.5500 in the space of a few short weeks.

On all three occasions, the NZD selling was well over-cooked, and it subsequently recovered strongly from each sell-off. The current international environment is much less severe for the Kiwi dollar than the three risk events cited above. The USD is at 20 year highs and more likely to depreciate and the Aussie dollar appears to be the most undervalued currency going around right now. It seems unlikely that the current six cent plunge, largely due to US equity markets falling, will be extended and is more likely to quickly reverse.

Q2: Does the US dollar value peak when US inflation peaks?

Most likely, however accurately forecasting the timing of the peak in US inflation increases this year may prove to be a very difficult job, as the Fed found out last year when they forecast inflation increases to be “transitory”. The annual US “core” inflation rate (excluding the volatile food and energy prices from the headline number) is however likely to decrease over the next three months as the sharp +/- 1.00% monthly inflation increases in April/May/June 2021 drop out of the annual figure calculation and are replaced by lower price increase across those same three months in 2022. Certainly, the main culprits a year ago, used cars and lumber prices are now moving back down. The significant oil price increases in February and March are not likely to be repeated over coming months either. As the annual core inflation rate tracks lower instead of higher, interest rate and FX markets will be re-considering whether they have already priced-in too much in the way of Fed monetary tightening. The US dollar would weaken under this market adjustment scenario, but it may also require evidence that US economic activity is also slowing (particularly, the number of new jobs added each month).

Q3: Will the NZ dollar recover if and when US equity markets recover?

The April “tech wreck” in US equity markets has certainly hurt the NZD and AUD currency values over recent weeks as investor sentiment has turned to “risk-off” mode. The big tech stocks will re-attract buying interest at their now lower values only when the long-term risk-free interest rate (10-year Treasury Bond yield) stops increasing and reverses lower. The bond yield determines the discount rate applied to enterprise/share valuations. Bond yields will only stop increasing when the bond market is convinced that US annual inflation has peaked (see Q1 above). The US 10-year bond yield has more than doubled from 1.50% in January to 3.14% today. After a run like that, at some point soon the bond market “short-sellers” must be taking their considerable profits i.e. buying the bonds back and forcing the yield lower. Famously revered investor, Warren Buffet is now buying equities as panic sellers force share prices below where economic growth and thus corporate profit levels suggest where they should be.  

Q4: Will the AUD’s fortunes continue to be the dominant determinant of the NZD/USD direction?

Absolutely! The day-to-day correlation of the two exchange rates remain strong, albeit the Kiwi is underperforming somewhat as evidenced by the continuing slide in the NZD/AUD cross-rate to 0.9060. The AUD/USD rate has bounced back up again from rates between 0.7000 and 0.7100 on three separate occasions over the last six months. It is expected to hold above 0.7000 once again and reverse higher over coming months. Once the Australian Federal Election is out of the way after 21 May, the coast will be clear for the AUD to attract considerable global buying interest, backed by its spectacular economic fundamentals of +4.5% GDP growth in 2022, bulging external Balance of Payment Current Account surpluses and high metal/mining commodity prices.

Q5: How does Chinese Premier Xi extricate himself from his Covid-zero predicament?

Who knows! China should start to realise very soon (as Jacinda eventually realised) that Covid -zero elimination policies in the end impart too much economic carnage. The Chinese will respond to this unanticipated economic downturn in the same way they have reacted to all previous economic slowdowns i.e. large-scale fiscal and monetary policy stimulus packages. Watch this space and when they announce such economic measures it will be positive news for the Kiwi and Aussie dollars.

Q6: Should immigration policies replace monetary policies to combat high inflation?

When our high inflation all comes from the supply-side, clobbering consumer demand with high interest rates will not be that effective in reversing the underlying causes. Low income households suffer the most as staples make up a much larger proportion of the weekly budget. Supply chain bottlenecks, product shortages and delays are all contributing to the price rises and the common-denominator is labour shortages. No surprise that wages are being bid up in both New Zealand and the US, therefore the answer is to increase the supply of labour. Joe Biden and Jerome Powell in the US may come to realise this as employment growth slows as there is no-one available to hire. They will need to change their immigration policy to force inflation down for the good of the public and the economy. New Zealand should take note and follow suit.

*Roger J Kerr is Executive Chairman of Barrington Treasury Services NZ Limited. He has written commentaries on the NZ dollar since 1981.