Roger J Kerr says Australia will out-perform New Zealand in the GDP economic growth stakes this year, but the interest rate differential will remain in favour of NZ over coming months with our  wage-push and sticky inflation problem

• Summary of key points: -

• The USD holds its gains from marginally stronger economic data
• The Kiwi/Aussie dollar cross-rate: Opportunities and dangers

The USD holds its gains from marginally stronger economic data

The US dollar has held on to its gains to $1.0600 against the Euro over this last week. However, there has been no follow-through USD buying stemming from the marginally higher US inflation and activity indicators over recent weeks.

Thursday’s US ISM Non-Manufacturing (i.e. services) survey result was eagerly anticipated as confirmation, or not, of the US economy picking up some steam again. The forex markets would have been disappointed that the survey results were a real mixed bag and provided no clear evidence of resurging activity. The overall PMI index was above forecasts of 54.5 at 55.1. However, the ISM prices sub-index was lower than the 67.0 forecast at 65.6. The focus over this next week will be the US Non-Farm Payrolls jobs numbers on Friday 10th March. Consensus forecasts are for an employment increase of 200,000 for the month of February, following the massive 517,000 increase in January. A result well north of 200,000 will be positive for the USD as it will confirm expectations that the Fed will still need to push interest rates higher for longer. A result well below 200,000 and a potential revision downwards in the January figure would be USD negative and would push the NZD/USD rate back up again.

As expected, Chinese economic data is already coming in a lot stronger than what most anticipated. Chinese Caixin and NBS Manufacturing and Non-Manufacturing PMI surveys for the month of February were all well above prior forecasts over recent days. Their import/export trade data for January and February being released this Tuesday 7th March might again surprise the markets with the speed of the recovery from declining trends over the last 12 months. It is still expected that the NZD and AUD will benefit from stronger than anticipated Chinese economic data over coming weeks/months.

It was instructive for the near-term direction of equity, bond and FX markets that the US Dow Jones Index bounced back up from the 32,600 level again this week, replicating several recoveries in the market from that point since November. The 380 point gain in the DJI on Friday 3rd March suggests that equity investors do not buy into the current bond market pricing that the Fed will need to push interest rates well over 5.00% to contain resurging inflation. The US 10-year Treasury Bond yields traded over 4.00% last week (currently 3.95%), however it looks like a severe over-reaction by the bond market to only marginally stronger economic data. As weaker US data emerges and the annual inflation rate reduces sharply over coming months, lower bond yields back to 3.50% and therefore a lower USD value (which follows) has to be expected.

The Kiwi/Aussie dollar cross-rate: Opportunities and dangers

The up and down yoyo movements of the NZD/AUD cross-rate may be perplexing at times; however the regular gyrations do present dangers, but also opportunities, for both local AUD importers and AUD exporters to hedge their future AUD payment/receipt cashflows forward at attractive and profitable levels. If the daily NZD/USD movements in the forex markets exactly match AUD/USD movements the NZD/AUD cross-rate remains totally stable. However, over recent years, long periods of stability in the NZD/AUD rate have been very rare indeed. It seems the Kiwi dollar is always invariably under-performing or out-performing the AUD against the USD in the currency markets, resulting in the NZD/AUD rate swings and volatility. The reasons for the NZD shifting at a different pace to the AUD are many and varied, however it generally boils down to the FX market’s expectations on future interest rate movements for the two economies/currencies. In turn, these are driven by what the two respective central banks, the RBNZ and RBA are saying and doing at the time. If local importers and exporters do not proactively hedge this currency risk forward, the often rapid changes in the exchange rate direction can seriously hurt business profit margins.

Over the last 12 months the NZD has depreciated sharply against the AUD from peaks of 0.9600 on two separate occasions. AUD importers who have cemented hedging around these spikes higher have locked-in valuable hedged positions. AUD exporters who have not operated multi-year hedging policies have lost product-price competitiveness or profit margins on these upward spikes to 0.9600. Exporters were presented a golden opportunity to secure excellent hedging levels on the plummet t0 0.8750 in September 2022 when the lower market liquidity levels in the NZD/USD FX market exaggerated the NZD/USD plunge to 0.5550 (more so than the plunge in the AUD against the USD at the time). The breakout below 0.9000 in the NZD/AUD cross-rate at that time was a little surprising as the NZD/AUD had staunchly remained in the broad 0.9000 to 0.9700 trading range over the previous eight year period.

The NZD/AUD exchange rate did not remain below 0.9000 for very long with the RBNZ re-exerting their tight monetary policy stance in November 2022. Contemporaneously, at that time the RBA were publicly pontificating about going slower on their interest rate increases to bring inflation down. The forex market traders and speculators instantaneously reversed their positions on the NZD/AUD cross-rate from short-sold Kiwi to long-Kiwi. The NZD/AUD cross-rate immediately spiralled higher to 0.9600 by late December as a result. Through January and February 2023 the NZD/AUD again reversed its direction, falling away from 0.9600 to a low of 0.9050 two weeks ago. The FX markets yet again pricing the NZD weaker/AUD stronger as they anticipate that the RBA have a lot more to do with interest rate increases from their current 3.35% OCR level (compared to New Zealand’s 4.75% OCR interest rate).

The ever changing market perceptions and expectations on the differing monetary policy stances by the RBNZ and RBA explain the reasonably wild volatility in the NZD/AUD cross-rate. Interest rate differentials in favour of the NZD suggest the NZD/AUD cross-rate should be higher than the 0.9100/0.9200 region. On the other hand, commodity price differentials favour the AUD over the NZD, pointing to a lower cross-rate. The interest rate differential driver of the NZD/AUD cross-rate seems to be winning out currently and should continue over coming months. The rebound upwards from 0.9050 two weeks ago to 0.9240 currently confirmed strong interest to buy the NZD on dips from both speculators and hedgers alike. The RBNZ re-stating their hawkish monetary policy stance last week lifted the Kiwi dollar independently of the Aussie dollar.

It is not just trade-related transactions from importers/exporters and currency speculators who influence the NZD/AUD cross-rate, two additional forces come from: -

• Equity investment fund managers on both sides of the Tasman actively increase and decrease their NZD/AUD hedged positions depending on technical signals, investment portfolio weightings and economic forecasts.
• The Aussie-owned big-four NZ banks repatriate their annual profits in the form of dividend payments to their respective parent companies in October/November each year. The plunge in the NZD/AUD cross rate in late 2022 was partially attributable to these multi-billion flows, the four banks all selling NZD’s, buying AUD’s at one concentrated point in time.

Looking ahead, whilst Australia will out-perform New Zealand in the GDP economic growth stakes this year, the interest rate differential will remain in favour of NZ over coming months with our  wage-push and sticky inflation problem. Exporters should already be holding high hedged levels and importers can target 0.9500/0.9600 as a new hedge entry level. The second half of 2023 may see a lower NZD/AUD cross-rate again as a weaker NZ economy forces the RBNZ to potentially pause on interest rate increases ahead of the RBA doing so.  

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