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Summary of key points: -
- US financial market pricing jumps from one extreme to another
- China is roaring back – what it means for the NZ economy and NZ dollar
- New Zealand needs more people – more than ever!
US financial market pricing jumps from one extreme to another
Over the course of the last month, pricing in the US financial markets (FX and interest rate markets) has quickly shifted from an overly-optimistic position of expecting the Fed to cut interest rates in late 2023, to an arguably overly-pessimistic position of the Fed still needing to ramp interest rates even higher to bring inflation down.
The change is best demonstrated by the movements in the US two-year interest rate swap rate which builds in all expected future changes up and down in the Fed Funds interest rate over the next two years. A month ago, the two-year swap rate was as low as 4.05%, given that the current Fed Funds interest rate is 4.50%/4.75%, that forward pricing was factoring-in significant interest rate reductions in 2024. The Fed were seen at that time as being uncomfortable that the markets were so aggressive in expecting a pause and pivot in monetary policy this year. However, a series of US economic releases over recent weeks for the month of January, from jobs to retail sales, to inflation have all printed on the marginally stronger side, compared to prior consensus forecasts. The markets’ response appears to be a massive over-reaction the other way, pushing the two-year swap rate up to 4.65%. The long-term US 10-year Treasury Bond yield has increased from 3.40% to above 3.80% over the last two weeks.
The forex market has reacted in the same manner as the interest rate market, the USD Dixy Index previously on a firm downtrend below 102, has moved abruptly up to a high of 104.5 (currently 103.8). Mirroring this overall USD strength, the NZD/USD exchange rate has been shunted lower from 0.6500 to 0.6200 (currently 0.6250). The Kiwi dollar attracted buying interest in the 0.6200 to 0.6250 range on two separate occasions over the Christmas/New Year period. Ahead of the RBNZ Monetary Policy Statement this Wednesday 22nd February, FX market participants are once again likely to see the Kiwi dollar as cheap to buy at 0.6250.
The question is whether the recent marginally stronger US economic data is a sea change in the direction of the US economy and is representative of fresh and increased inflation risks ahead for the Fed to deal with. We do not think so. The January Non-Farm Payrolls blockbuster number of +517,000 appears to be an aberration and not reflective of the actual labour market conditions. The percentage increase in retail sales for the year to January was really no more than the price increases over the last year (inflation rate) and therefore retail volumes are flat. The January CPI inflation result was precisely on prior market forecasts, so not a surprise to the upside. There is nothing to suggest that the decline in the annual US inflation rate will not continue over coming months at the same rate it has been falling at since last June. The annual inflation rate is already down to 6.40% from the 9.10% peak in June 2022. Over the next five months, monthly inflation increases between 0.20% and 0.40% each will replace successive monthly increases of 0.70%, 1.00%, 0.40%, 0.90% and 1.20% between February and June 2022. The annual headline inflation rate is set to plummet from 6.40% to somewhere around 3.50% over the next five months. The prices for goods and services that sky-rocketed upwards over this February to June period in 2022 are not being repeated in 2023. The lagged shelter CPI component (rents) will soon reverse from monthly increases to monthly decreases. Oil prices have stabilised at the lower US$75 to US$80/barrel range.
The financial markets have knee-jerked to some short-term and mild volatility in the US economic data. The wider picture is one of rapidly declining US inflation and the Fed being applauded for orchestrating a soft landing for the economy. The Fed will not be adjusting their policy stance and they will be happy to get the annual inflation rate down so quickly to 3.50%. Therefore, the current market pricing, in our view, is unsustainable. It is anticipated that the USD will return to its previous downward track over coming weeks/months, lifting the NZD/USD rate back to 0.6500 and higher.
China is roaring back – what it means for the NZ economy and NZ dollar
Chinese households are no different to households in the western world. Having been locked down by Covid for an extended period they will behave in the very same way as the west when the restrictions are abandoned. Accumulated savings and pent-up demand results in a consumer spending spree once the population is free. We have not yet seen official Chinese economic statistics that evidences this massive rebound in activity, however anecdotal evidence is one of resurging demand and rising prices. New Zealand’s log exporters are already witnessing unexpected and sudden strong demand resulting in rising export prices through January and February as the Chinese construction industry moves back into full swing. The last Fonterra Global Dairy Trade auction on 7th February saw an unexpected 3.80% increase in whole milk powder prices to US$3,329/MT due to stronger Chinese buying demand. The price lift was a sharp turnaround from declining prices over the previous four months. Whole milk powder futures prices for August this year are now trading at US$3,470/MT, therefore expect higher dairy prices again at the GDT auction this Tuesday night, 21st February. Chinese families easting out again at restaurants is very good news for New Zealand’s beef, lamb, crayfish, mussels and fruit exporters. Rising export prices will be some small compensation for our growers in the Hawkes Bay and Gisborne regions suffering from the carnage of destruction of Cyclone Gabrielle.
Over coming weeks, Chinese economic data being released includes February manufacturing PMI, services PMI, import/export trade, CPI inflation, vehicle sales, lending growth, industrial production and retail sales. All the figures are expected to record significant increases as the post-lockdown economic activity roars back. In currency markets, the historical pattern has been strong Chinese economic data equates to positive news for the AUD and NZD exchange rate values. The weaker economic trends in China over the last two years has certainly been one of the reasons why the AUD and NZD have under-performed. US-based hedge funds often buy the Aussie dollar as a “proxy-trade” to benefit from a stronger Chinese economy.
The return of China is also a positive for the global economy. Over recent weeks we have already seen institutions like the ECB, IMF and World Bank increase their global GDP growth forecasts for the second half of 2023. Their GDP growth forecasts were previously consistently revised downwards as tight monetary policy and Covid lockdown hit global consumer demand. Investment banks forecasting a global economic recession in 2023 was the main reason they viewed the US dollar as staying strong, as the USD apparently always gains in such economic conditions. As the probability of a bad global economic recession recedes, those FX forecasts for a strong USD will need to be hastily revised.
There is no question that China is back much earlier, faster and larger in early 2023 than what anyone envisaged. Whichever way you look at it, that is very good news for the NZ economy and therefore the NZ dollar value.
New Zealand needs more people – more than ever!
Everyone should be encouraged to read the very timely and poignant NBR article on immigration by the new Auckland Chamber of Commerce head, Simon Bridges published last week. Simon correctly points out that New Zealand’s economic history and development has always been based around the skills, innovation and drive of immigrants. The English and the Dutch immigrants came into New Zealand in the 1950’s and 1960’s and contributed in no small way to the construction of our hydro dams for electricity, the dairy industry and many other industries. The Dalmatians built our wine and fishing industries. Polynesians came into New Zealand in the 1960’s and 1970’s to work for better opportunities and lives for their children. More recently, South African, Asian, Indian and Middle-Eastern immigrants have arrived and contributed to our economy.
Large increases in immigration inflows into New Zealand is nothing new.
Right now, given the acute worker shortages across most industries and the additional human resources needed for the Cyclone Gabrielle rebuild, the Government needs to make some immediate and bold decisions to get more immigrants into New Zealand. We may already be too late in securing skilled and semi-skilled talent from offshore, the West Australian State Government is currently running promotions in the UK to attract in an additional 30,000 workers into their economy. Given the current economic environment in the US and Europe, it is an ideal time to be selling New Zealand to prospective immigrants. Why aren’t we doing it?
Unfortunately, there is a reasonably large xenophobic element in New Zealand society who are anti-immigration. They fear foreigners taking their jobs and pushing up house prices to unaffordable levels. We have politicians who play on those (usually misplaced) fears and therefore our immigration policies and processes over recent decades have been inconsistent, disjointed and cumbersome.
However, to return our health and education levels to the previous first-world standards we once prided ourselves on, we need an expanding and vibrant economy. Trade-offs need to be made. To achieve that, the economy requires immigration levels returning to 5,000 net inflow per month (60,000 per year). History tells us (refer to the chart below) that periods of strong migration inflows align with accompanying NZ dollar currency gains. Immigrants not only bring in their capital (positive for the NZD), but they also add to economic growth.
A return to increased migrant inflows over coming years suggests some NZ dollar appreciation in its own right.
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*Roger J Kerr is Executive Chairman of Barrington Treasury Services NZ Limited. He has written commentaries on the NZ dollar since 1981.
11 Comments
"" the Government needs to make some immediate and bold decisions to get more immigrants into New Zealand....Unfortunately, there is a reasonably large xenophobic element in New Zealand society who are anti-immigration. ""
I'm an immigrant. I have a multi-ethnic family that I love. Of course NZ must have immigrants; probably better ones than myself. However NZ has tried massive net immigration ever since WW2 and although it has been good for the immigrants themselves it has not been good for our economy. So why will it work this time? Every NZ govt both Labour and National have claimed to be running a 'skilled immigration' policy so why are we so desperately in need of skilled workers?
Arguing against all immigration is xenophobic but querying why NZ needs massive net immigration is not.
NZ needs more migrants like you, nicely said. If we could actually bring in skilled and educated workers that would be one thing, but like you said, both Labour and National have not be able to do this. I think we need a better approach. Anyway, I guess I'm xenophobic, sigh...
I arrived 20 years ago. there was a shortage of computer programmers and modestly I was a highly experienced programmer. But really I was too old so it is quite debateable whether NZ really benefited from my few years of taxable work. The problem 20 years ago was one of keeping NZ computer programmers in New Zealand. I had met many working overseas. That is still the problem; importing IT staff has not solved it. Our govt is using immigration to avoid tackling serious problems that are getting worse. As NZ's economy sinks in comparison with the rest of the world (recently overtaken by Poland and Lithuania) it will get ever harder to find 3rd world nurses to come here when they can get more pay and cheaper accommodation elsewhere.
""History tells us that periods of strong migration inflows align with accompanying NZ dollar currency gains."" Every immigrant is like a temporary sugar rush to the economy. They arrive and need housing, cars, white goods, new schools and hospitals, etc. Of course they boost the economy for a short while. The NZ currency gains helps every Kiwi when buying imports but it equally hits our exporters. The proportion of our exports to our GDP has been falling for years whereas in most countries it has been increasing. In the long run not good for NZ.
Nor is loading more and more inflated living costs onto the wider populace. A weaker dollar means more expensive everything, be it services from overseas, imported goods or anything transported reflecting higher food costs. And the same exporters who cream it are the ones who are also pricing their wares in our local market at global prices to boot. Cue anecdotes about NZ meat and cheese being cheaper on the other side of the world than it is in NZ.
60000 migrants a year would place NZ among the top (if not #1) in the OECD in terms of migrants per capita.
That sort of immigration is too quick and strains both our infrastructure and the ability of migrants to assimilate culturally into NZ (which is part of the social contract of immigration).
So while it may be a benefit to parts of the economy it strains other parts, e.g need to build more houses, roads, hire more doctors, build more schools etc etc. At some point a country needs to find the right mix of skills within their own borders.
I suggest a sustainable level of net migration is around 20000, SKILLED migrants.
National previously has not cared about the quality of migrants at all. Which has contributed to many bad outcomes, including our infrastructure deficit but at least there are lots of bottle stores and Ubers around I suppose……
Allowing a huge influx of immigration without immediate changes to housing policies is simply nuts, frankly nothing short of irresponsible. We have seen this play book before with disastrous results. National and its supporters need to get past ad hoc immigration policies.
We need a serious debate about long term population policies and to develop long term infrastructure policies.
given the acute worker shortages across most industries
Don't you mean acute refusal of NZ businesses to pay more and or train staff?
They fear foreigners taking their jobs and pushing up house prices to unaffordable levels.
This is not the definition of someone who is xenophobic. The author even admits not all these fears are without reason and I do wonder what he thinks will happen if, all else is held even, supply (of labour) increases or indeed demand (for houses) increases.
we need an expanding and vibrant economy
Does the author ever think this 'expanding' should stop, or does he see no limit to the expanding of population and accompanying resource usage NZ can accommodate?
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