Roger J Kerr says an RBA interest rate hike next week would certainly propel the AUD/USD exchange rate higher, and the NZD/USD rate will follow

Summary of key points: -

• The US dollar fails to appreciate on stunning GDP growth data
• Reserve Bank of Australia moves close to an interest rate hike
• China’s new export – deflation!

The US dollar fails to appreciate on stunning GDP growth data

The value of the US dollar has oscillated between 105.20 and 107.00 on the Dixy Currency Index over this past month.

Three pullbacks in the USD Index to the bottom of that range and three spikes to the top, however no follow-through buying the take the USD higher.

The USD gains have been off the back of generally stronger than expected US economic data like the PMI manufacturing survey and retail sales for September. It is not that the US economic results have been that strong, it is just that they are far superior to equivalent European economic numbers currently and the USD has consequently appreciated against the Euro.

However, it does appear that the FX markets are reluctant to push the US dollar any higher, as even though the recent historical data has been relatively better than elsewhere, on a look-forward basis there are several signs suggesting that the positive economic impetus will not continue. US GDP growth data for the September quarter was released last week and the 4.90% expansion (annualised percentage for the quarter’s activities) was, on the surface, a stunning figure (well above prior consensus forecasts). However, it is very instructive for the sentiment in the currency markets is such that the US dollar failed to make further gains on such brilliantly positive economic news. The FX markets are always pricing the future, not the past, therefore it cannot be too much of a surprise that the US dollar has run out of steam and failed to appreciate on the GDP growth news.

In looking ahead and pricing the future economic conditions, the currency markets are correctly assessing that the strong US consumer and Government spending that produced the 4.90% GDP growth rate in the September quarter will not continue over coming quarters.

It seems that US consumers have had their summer fling, spent the last of the Government Covid cheques and are now tightening their belts for some upcoming tough winter months. In respect to the US Government spending, there are clear signals that this must be reined-in as Treasury Bond yields soar to 5.00% due to the additional supply of bonds exceeding investor demand (bond prices lower, yields up). The Biden Administration is seeing first-hand every day (via the bond market) that the US does not have sufficient savings/investment funds themselves to fund their own Federal Government deficits. The bond market is telling them that they need to reduce their fiscal spending levels. Otherwise, the sharply higher market interest rates will by themselves tighten monetary conditions and cause an economic downturn without the Federal Reserve doing anything more.

The financial markets are not expecting any further interest rate hikes from the Fed at their Wednesday 1 November meeting this week (Thursday 7am NZT). The wording of the Fed statement will be the central focus for the markets in terms of how the Fed see the US economy performing in 2024 and therefore the likely timing of the first interest rate cuts. To date, the Fed has been very gun-shy at making statements about future economic conditions as they were so badly burnt on the “transitory inflation” botch-up some 18 months ago. So far this year they have been adjusting their monetary policy stance on historical employment and inflation data. That is why it has taken them so long to confirm that inflation is under control and trending down to their 2.00% target. Therefore, do not expect any forward guidance from the Fed, however they cannot ignore the current weaker forward economic indicators of new housing starts plummeting, consumer confidence reversing back down (refer chart below) and auto loan/credit card default levels skyrocketing.

US equity markets in falling for most of the last two weeks (despite some positive earnings results) is also sending a message that the general economic conditions in the US over coming months will be far more challenging.

US PCE inflation figures for the month of September printed in line with forecasts on Friday October 27th, with the core inflation index increasing by 0.30%. Outside of the Fed meeting this week, employment costs, house prices, factory orders and Non-farm Payrolls on Friday 3rd November are all expected to confirm the anticipated slowing up in US economic activity. The US dollar requires strong economic data to continue its recent gains as stronger data suggest that interest rate will be held higher for longer next year.  When the stronger economic outcomes fail to materialise, the currency speculators are more likely to be selling the USD as they anticipate lower US interest rates in 2024.

Reserve Bank of Australia moves close to an interest rate hike

We have long expected new RBA Governor Michele Bullock to take a more stringent stance on monetary policy settings to get inflation down earlier than her predecessor.

The minutes of the early October RBA meeting made it very clear that there is less tolerance for inflation remaining above their 2.50% target level for long periods than under the previous Philip Lowe regime. Statements and inferences from Ms Bullock to date support that view. Australian inflation data for the September quarter was above forecast and the interest rate markets are now pricing-in a 50% chance of a 0.25% interest rate increase from 4.10% when the RBA next meet on Tuesday 7th November.  The reality is sinking home to the RBA that current trends with wages, electricity, rent and imported consumer goods are all heading higher.

The RBA has been far too complacent with their monetary policy settings to bring inflation down and it appears that they are finally realising that their interest rates are not high enough to achieve their inflation goals.

The Aussie dollar has found some amount of support at the lower 0.6300 level, having bounced back up from that point on five occasions over the past month. An RBA interest rate hike next week would certainly propel the AUD/USD exchange rate higher, and the NZD/USD rate will follow.

China’s new export – deflation!

Anecdotal news from consumer goods trade fairs in China over recent weeks is that the Chinese exporting manufacturers are cutting their prices to stimulate higher sales.

It cannot be too surprising that China is now exporting deflation to the rest of the world given their low internal inflation rate, wages no longer increasing and the weaker Yuan exchange rate. All the stars are aligned for western economies to import Chinese manufactured product at lower prices. The only problem is that high interest rates is hurting consumer spending in those western economies. So, we are not back to the halcyon days of 2014 to 2018 when imported Chinese deflation disguised high and persistent domestic (non-tradable) inflation in New Zealand.  However, as prices for consumer goods reduce, inflation decreases, and lower interest rates follow.

The big question for the outlook on the NZD/USD exchange rate is whether US interest rates reduce next year well ahead of cuts to NZ interest rates. US inflation is already much lower than inflation in New Zealand (3.50% compared to 5.50%) and all the component parts of the US CPI are trending lower. The same cannot be said for our inflation make up, with domestic/non-tradable inflation remaining sticky high at 6.00%. The difference is that we have “wage-push” inflation, and the US does not. For this reason alone, US interest rates will reduce in 2024, whereas the RBNZ will hold our OCR stable at 5.50% for most of the year. The widening interest rate differential in 2024 will be the principal reason for a Kiwi dollar recovery against the USD.

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