By Roger J Kerr
Global foreign exchange markets have reacted violently to the latest US jobs figures for the month of May, the US dollar value tumbling against all major currencies.
The Non-Farm Payrolls employment result last Friday was a true shocker with only 38,000 new jobs created against prior forecasts of +165,000.
The USD Index fell immediately from above 96.0 to near 94.0 as the markets removed any bets that the US Federal Reserve will increase their Fed Funds overnight interest rate at their FOMC meeting on 16 June.
The large forecast miss for the jobs data does not seem right. The actual result appears to be a total outlier, or rogue number that will be subsequently corrected and revised upwards over future months.
There is no way the US economy suddenly lost all its momentum during the month of May and employment growth suddenly fell into hole. None of the other lead indicators for the US economy suggested any such pronounced slowdown in activity or new hiring over the month.
The Federal Reserve will be cautious not to read too much into this one piece of the economic data jig-saw. Even though the US dollar plummeted from $1.1100 to $1.1350 against the Euro on the employment outcome, it appears to be a total over-reaction by the forex markets, as the Federal Reserve could well still increase their interest rates in July if this shocking jobs result is proven to be a rogue number.
Along with other currencies against the USD, the Kiwi dollar jumped from 0.6850 to a high of 0.6959 on the jobs data news.
The overall NZ dollar value as measured by the Trade Weighted Index (TWI) has soared to a new high of 74.00.
The latest appreciation of the NZ dollar, especially against our largest export trading currencies of the USD and AUD, places renewed pressure on the Reserve Bank of New Zealand (RBNZ) to cut interest rates again.
Both the TWI at 74.00 and the USD above 0.6900 do not provide a path for New Zealand’s annual inflation rate to get back within the prescribed 1.00% to 3.00% band anytime soon.
As the RBNZ have been below the minimum of 1.00% for more than 12 months now, the only decision they can make at their Monetary Policy Statement (MPS) this Thursday 9th June is to cut the OCR by another 0.25% to 2.00%.
If they decide the leave the official interest rate unchanged, the Kiwi dollar will strengthen to above 0.7000 and move them even further away from their required inflation target band.
A decision not to reduce the OCR would be seen as a failure of the RBNZ to manage monetary policy to maintain inflation within the target range. In military terms, a serious “dereliction of duty”.
Over coming days the interest rate markets and the NZD/USD forex market should adjust their pricing to build-in a much higher probability of an OCR reduction to 2.00% on the 9th.
Up until the US employment data caused a massive reversal of engines in the currency markets, it appeared that the USD was on a firm strengthening trend as the Federal Reserve conditioned expectations expertly for an interest rate lift in June or July.
Governor Wheeler at the RBNZ would have been pleased at those previous market developments, as a NZD/USD rate back at 0.6500 by natural USD strength may have negated the need for him to cut NZ interest rates. The recent USD slump in value will have the RBNZ hastily revising their decision and market messaging/signalling in Thursday’s MPS.
Prior to the US employment statistics that so dramatically weakened the US dollar last weekend, the NZ dollar was making some gains of its own on the back of still robust business confidence and a Terms of Trade Index that unexpectedly increased by 4% in the March quarter.
It would be incorrect to read too much into the Terms of Trade lift as a positive for the NZD and justification for a higher TWI value. The Terms of Trade index rose on a decrease in imported fuel costs due to the collapse of crude oil prices in January to below US$30/barrel. The improvement was not due to increasing export prices which would be positive for the currency. Over recent weeks the oil price has increased sharply to US$50/barrel, therefore the Terms of Trade Index will be falling back down again on higher import prices in the June quarter.
Further NZ dollar negatives over coming weeks/months will be the growing cash flow/profitability crisis in our largest industry, the dairy sector, and the current position of the NZD/AUD cross-rate at 0.9420. The currency speculators who have purchased the NZD against the AUD over recent months will be keen to take their profits and become large-scale NZD sellers at these elevated NZD/AUD cross-rate levels.
The RBNZ need to realise that other banking regulatory controls and government/local government initiatives are being actioned to contain the housing market speculative bubble. Not cutting interest rates (as it may fuel the housing market further) would be a monetary policy mistake as the dairy and inflation objectives/responsibilities are much greater at this juncture for the RBNZ.
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Roger J Kerr is a partner at PwC. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com
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