Roger J Kerr says the lack of buying interest in the US dollar on the Middle East shock underscores just how much the attitude and sentiment of investors has changed over the last six months since Trump came to power and upended the world order

Summary of key points: -

• The US Dollar is no longer the “go-to” safe-haven currency it once was
• Is the Fed still looking backwards at historical economic data, or not?
• NZ dollar uptrend intact as it holds above 0.6000

The US Dollar is no longer the “go-to” safe-haven currency it once was

The reaction by global financial and investment markets to the outbreak of war between Israel and Iran over the last few days has been very instructive in how the world now sees the US dollar as a currency.

The unwritten convention, in the past, for investors has been when geo-political risks skyrocket is to shift assets to the security and safety of the traditional safe haven destinations – gold, the Swiss Franc, US Treasury Bonds and the US dollar. The price of gold is already at record highs; however, it found fresh demand on the Israeli missile strikes. However, US bonds and the US dollar were not in demand as a safe haven, 10-year bond yields where largely unchanged at 4.40% and the USD Dixy Index is trading near to its lows at 98.00. The total lack of buying interest in the US dollar on the Middle East shock underscores just how much the attitude and sentiment of investors has changed over the last six months since Trump came to power and upended the world order. No-one trusts the Americans any more as their economic and foreign policy agendas are chaotic, erratic and non-sensical.

In the US, the media and PR hype surrounding Trump has always been that he is an experienced businessman, who knows how to negotiate for America’s benefit with the “art of the deal”. Unfortunately, the reality of what Trump has achieved since coming to office is a litany of failure. Consider the following track-record of Bozo the Clown currently in the White House: -

• Trump’s talks with Iran on a nuclear deal are in complete tatters as Israeli intelligence picks up Iran’s nuclear arms production, promoting them to strike first.
• Peace in Gaza seems further away than ever.
• Peace in the Ukraine/Russian war has slipped off Trump’s agenda as Putin plays him like a fiddle.
• The Trump heralded “Big Beautiful Tax Bill” is a mess with tax revenue lower and Government spending higher. The bond market has delivered its verdict on Trump’s economic policy agenda, which is creating a large budget deficit and therefore more debt, with substantially higher market yields (increasing the Government’s borrowing costs exponentially). Thanks Donald!
• Tariff and trade agreements between the US and most countries are bogged down. Trump has now stopped negotiating and will soon introduce unilateral tariff increases without formal agreements. The Chinese are keeping Trump on a short leash by only agreeing to six months’ supply of rare earth minerals to US defence and auto manufacturers.
• As the architect of the trade wars, all Trump has achieved is uncertainty, an impending supply shock and slower US and global economic growth. Thanks Donald!
• The Federal Reserve is paralysed by Trump’s tariffs, as they do not know how much the tariff increases will push up inflation. If it was not for the tariff uncertainty, the Fed would be cutting interest rates at this time to their neutral rate of 3.00%. We will not know how much damage the high 4.30% interest rates (restrictive monetary policy) are doing to the US economy until it is too late. Thanks Donald!
• The aggressive deportation of illegal immigrants from the US has resulted in small-scale civil unrest that has drawn an outsized response from Trump by sending in the National Guard and Marines. Military in your own streets sends shivers up the spines of foreign investors.

Another example of how much the US dollar has fallen out of favour as safe haven currency is the relationship of the USD to crude oil prices. Unsurprisingly, oil prices have shot up since the outbreak of war in the Middle East three days ago. The US dollar was tracking oil prices closely as lower oil prices reduce US inflation, allowing interest rate cuts and therefore a lower US dollar value. That correlation has abruptly ended as the US dollar has not followed the surge in oil prices to US$73/barrel (WTI) in recent days (refer chart below).

The wrecking ball that is Donald Trump was always expected to be negative for the US dollar value, and so it has proven to be the case. The depreciation of the US dollar, following the initial “Trump Trade” euphoria last November/December, has been exactly in line with what happened eight years ago in Trump’s first term as President. The depreciation this time around is more rapid as total confidence is lost by the rest of the world in the US Government’s economic policies.

Several months ago, we produced the chart below which depicts history being repeated with the USD depreciation and we expected the current plunge would follow the script all the way down to 95.00 on the USD Dixy Index. At 98.00 today, the USD Index is not far away from that target. The extended depreciation of the USD eight years ago would suggest that the currency has much further to fall below 95.00 on the Index on this occasion.

Currency speculators in the US are still holding on to “short-sold” NZD and AUD positions against the USD. The continuing USD selling will force those punters to unwind those positions as they start to incur unrealised losses. As the NZ dollar holds above 0.6000 and the AUD hold above 0.6500 against the USD, we are not far away from the time when the speculators will by buying back both currencies to close down their positions.

Is the Fed still looking backwards at historical economic data, or not?

The US Federal Reserve will deliver their next economic outlook, interest rate decision and “dot plot” of individual member’s own interest rate forecasts on Wednesday 18th June (Thursday 6.00am NZT). They will leave interest rates unchanged; however, the market interest will be on any of the subtle nuances in the statement and in the following media conference from Chair Jerome Powell. The Fed have been telling us for more than two years that they are looking backwards at the historical economic data to set monetary policy and interest rates. They have now abruptly changed away from that approach, telling us that the unknown of the tariff percentages on imports into the US means that there is considerable uncertainty around the future track of inflation. In other words, they are now looking forward and as a consequence are doing nothing.

If they were looking backwards at the recent weaker inflation and employment data they would be reducing interest rates, as the current 4.30% restrictive monetary policy settings are no longer required. If the increase in US inflation from tariffs all came at once (like an increase in sales tax – because that is what it is) the Fed would be justified in “looking through” the inflation bump and not altering their monetary easing cycle. The problem is that the tariff impact on inflation will be strung out over time as importers and retailers adjust prices in different ways. Trump believes that the foreign exporters will absorb all of the tariffs. However, that was never likely and already we are seeing the US importers, wholesalers, retailers and end consumers all paying proportions of the tariff impost. It is this logical commercial behaviour to retain sales levels without scaring the consumer away that is making the forecasting of the inflationary impact so difficult for the markets and the Fed. The CPI inflation result for the month of May last week recorded a 4.00% price increase in household electronic products and a 2.00% increase in toys, reflecting increased import tariffs. These were the first sign of some pass-through to consumes prices. The takeaway from the CPI data was that these imported products have such minor weightings in the CPI Index that the increases did not shift the dial on the overall low 0.10% increase for the CPI in the month of May.

The foreign exchange markets in pricing the US dollar lower today are telegraphing a message that they see the Fed being forced to recommence their interest rate cuts sooner than September and the likelihood of more than the two x 0.25% cuts that the interest rates markets are currently pricing. We will wait to see how many Fed members also see softer employment and inflation (before tariffs) as a good reason to lower their 12-month “dot plot” interest rate forecasts.

In some ways the Fed need monthly inflation figures to be moving upwards to justify their “on-hold” position. That is not happening and may never happen in the way many expected. If the underlying consumer demand is weak, the retailers have no pricing power, therefore all the players along the supply chain will absorb parts of the tariff and accept margin compression. The inflation impact from tariffs may prove to be much more muted and spread than most have feared. The probability of another Fed U-turn on monetary policy over coming months has gone up a notch.

The “core” inflation measure in the US removes energy prices and food prices from the overall headline PCE (preferred by the Fed) price index. The “supercore” inflation measure also removes rents from the core measure. Energy and food prices are influenced by many factors outside the Fed’s control with interest rate changes, hence removed from the PCE headline number to produce core inflation. Rents are also removed in the supercore measure as the data is 12 to 18 months out of date and not an accurate measure of current market rents. In May, the supercore inflation turned negative for the first time since Covid (see chart from zerohedge below). Supercore inflation (black line in the chart) dropped below zero. Health cost increases (orange bar in the chart) continued as a big component of monthly price increases in the US.

NZ dollar uptrend intact as it holds above 0.6000

New Zealand’s very positive “export-led recovery” economic story is not yet being recognised by global currency players because the “negative carry” (NZ interest rates below those of the US) dissuades them from buying the Kiwi dollar in its own right. The NZD/USD exchange rate is only moving higher due to the USD side of the equation being significantly weaker.

The export boom we are witnessing was confirmed by the stunning increases in the Ministry of Primary Industries’ Situation and Outlook report last week. Food and fibre sector export sales up 12% over the last year to a record high NZ$59.9 billion. Reports from last week’s Agricultural Fields Days in Hamilton confirm the vibrancy and confidence in our largest industry. History tells us that it takes 12 months for the booming regions to lift economic activity in the big cities. Reductions in interest rates in a monetary easing cycle also takes over 12 months to have a positive impact. Therefore, the depressed retail and residential property sectors in Auckland and Wellington can look forward to some material improvement come Springtime this year. 

GDP growth figures for the March quarter are due this Thursday 19th June. An increase above the 0.70% forecast will be positive for the Kiwi dollar as it would confirm the RBNZ’s hint that OCR cuts will terminate at 3.00%. The weakening USD has allowed the Kiwi dollar to make steady progressive gains from 0.5850 to above 0.6000 over the last month. Every pullback lower is ending a higher level than the previous dip (refer chart below). Further NZD gains well above 0.6000 will be dependent upon the US dollar Index continuing to fall from 98.00 to 95.00.

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