Roger J Kerr says the Kiwi dollar does appear to have more opportunity for upside over coming weeks and break above the temporary shackle at 0.6150

Summary of key points: -

• Kiwi dollar stuck in a narrow trading band
• Economic data – often not what it appears to be!

Kiwi dollar stuck in a narrow trading band

Competing forces of weaker and stronger than expected economic data in both New Zealand and the US over recent weeks has corralled the NZD/USD exchange rate into a narrow 0.6050 to 0.6150 trading band.

The Kiwi dollar had an unexpected, but brief, excursion higher to 0.6150 when a local bank did a handstand by suddenly reversing their previous forecast of NZ interest rate cuts by August to two 0.25% hikes over coming months. No other banks or economic forecasters seem to agree with them on the interest rate increases, however the view that interest rates cannot be reduced at all in NZ in 2024 has been reinforced. The NZD/USD exchange rate rapidly reversed from 0.60150 to 0.6050 when the US dollar appreciated on the January US inflation result being fractionally above the prior forecast of +0.20% at +0.30%. The narrow trading range has held firm over this last month; however, such stability cannot be expected to continue given the nature currency markets.

From current level of 0.6130, the Kiwi dollar does appear to have more opportunity for upside over coming weeks and break above the temporary shackle at 0.6150. The Reserve Bank of New Zealand’s (“RBNZ”) Monetary Policy Statement on Wednesday 28th February stands as a highly likely NZ dollar positive event as they reinforce the “higher for longer” message on interest rates to bring down sticky domestic inflation. There was a lot of anticipation ahead of last Friday’s speech from RBNZ Governor Adrian Orr that he would deliver a harder line on what the RBNZ could do to bring inflation down earlier. The speech was disappointing, in that like a lot of political, economic and business commentary in New Zealand, it spent a lot of time identifying and explaining the problem, however it was short on delivering suggested solutions. Governor Orr stayed in his lane with the speech, not pre-empting what the monetary policy committee might decide with the tone of message in the 28th February statement. The reality is that the RBNZ have been unable to pull inflation back to within the 1.00% to 3.00% target band after 18 months of tight monetary policy because the NZ dollar has been unable to appreciate (due to the US tightening at the same time, therefore a stronger USD). The persistent NZD/USD value in the low 0.6000’s for much of this period has not allowed New Zealand’s tradable inflation to reduce to zero or negative to offset the permanent high 3.00% to 4.00% non-tradable (domestic) rate of inflation. The RBNZ should fully explain this reason as to why they have failed to reduce the inflation rate, despite the tight monetary policy. However, do not hold your breath that such plain language explanations will be forthcoming.

What the markets and NZ public should also expect from the RBNZ, as the guardians of inflation that protects the value of our savings and future spending power, is an explanation with accompanying analysis as to what the root causes of the permanent 3.00% to 4.00% non-tradable inflation are. They have never been able to adequately explain why these particular prices in the economy continue to increase and why they are insensitive to interest rate increases. The problem with persistently high non-tradable inflation is not new, it has been this way for the last 15 years. You would think that the RBNZ would have identified the root causes by now!

Perhaps we can help with a summary of the causes: -

• No discipline over price and wage setting behaviour in the public sector (both local and central government).
• Lack of true competition in many sectors e.g. house building, supermarkets.
• Excessive Government regulation/legislation that adds burdensome overhead costs to business, which is passed through to households.
• Inconsistent immigration policies which have caused worker shortages and wage pressures.

The common theme through all these root causes is the Government itself, however, do not expect the RBNZ to call out their masters as the major culprits in this respect.

A push higher in the Kiwi dollar to above 0.6150 ahead of the RBNZ statement would maintain the NZD uptrend with the spot rate moving back above the 30-day average (red line on chart below) and the 30-day average remaining above the 90-day average (green line).

Economic data – often not what it appears to be!

Like many things in life, often what something appears to be is not what it actually is. The same phenomenon applies to economic data, particularly US economic statistics. Over recent weeks, US employment and inflation data has printed on the stronger side of prior forecasts, prompting the financial markets to become increasingly uncertain as to when and by how much the Federal Reserve will cut interest rates this year.

How some prices and jobs are measured in the US economy may surprise you in terms of accurately (or inaccurately!) representing current conditions: -

• The January Non-Farm Payrolls employment increase of 353,000 was double prior forecasts, partially because retail sector jobs increased 45,000 in the month. Just how that could suddenly occur when retail jobs were static all through 2023, it is the middle of winter with snow and ice, and retail sales were much weaker than expected over the month (-0.80% against forecasts of +0.30%). Dodgy and corrupt jobs data is the only explanation as a result of disproportionate seasonal adjustments to the jobs figures stemming from the volatile data in the Covid years.
• The “Shelter” component that measures housing costs in the CPI is still running at +6.00% per annum because the data collection on rents and “owner-occupied rents” are lease surveys completed six to 12 months ago. The data is not current market rents.
• Health insurance premiums as a household cost in the CPI series are not a measure of an average family’s premium change on an average insurance cover plan. The method the US Bureau of Statistics applies is to measure the change is total profitability of all health insurance companies and that is used as a surrogate for the health insurance premium increase or decrease. The CPI health insurance premium change in 2023 was calculated from the change in insurance companies’ profitability from 2020 to 2021!

Now you can understand why the Federal Reserve prefer the PCE (Personal Consumption Expenditure) deflator index as a more accurate measure of current US inflation than the CPI Index. However, there was a massive reaction by equity, bond and FX markets to the US CPI being +0.30% for January, fractionally above the +0.20% forecast. Two-thirds of the +0.30% increase was the “Shelter” component which is 12 months out-of-date data. The extreme short-term movements in the markets are largely due to the algorithms in the trading programmes and momentum models automatically generating further massive buy/sell orders once certain price shifts occur. The intra-day volatility is certainly not a reliable representation of overall economic trends.

There is a good chance the momentum models will send US equities higher, bond yields lower and the USD Index lower when the more accurate inflation measure, the PCE Index, is released for January on Friday 1st March. Consensus forecast are for a 0.20% increase, which will replace a high 0.60% increase in January 2023. As a result, the annual headline PCE inflation rate will reduce from 2.60% to 31 December 2023 to 2.20% as of 31 January 2024. Such a low outcome is likely to reverse any market sentiment that US inflation is at risk of rising again.

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