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Roger J Kerr says the implications of US interest rate increases and a stronger US dollar in international currency markets over coming months are numerous and generally negative for the Kiwi dollar

Currencies
Roger J Kerr says the implications of US interest rate increases and a stronger US dollar in international currency markets over coming months are numerous and generally negative for the Kiwi dollar

By Roger J Kerr

The NZD/USD exchange rate climbed to 17-month highs of 0.7480 on two occasions last week (7th and 8th September), however the twin peaks could not be sustained as the US dollar itself rebounded in global FX markets.

A stronger US dollar on the international stage has been cited as a major reason why the NZD/USD rate is expected to retreat back to below 0.7000 over coming months. However, the performance of the US economy has been a very mixed bag of late.

The late August speech at Jackson Hole by Federal Reserve Chair Janet Yellen buoyed up the USD bulls as it was confirmed that economic conditions were aligning for another US interest rate increase in September or December.

Subsequent to the Yellen speech, US economic data has printed on the weaker side with the August jobs increase at 150,000 marginally less than expected and both manufacturing and services ISM surveys falling away.

There is a hint in the latest economic data that US business firms may just be holding back a tad on new investment /expansion plans in response to potential political uncertainty in the lead up to the November Presidential elections. Not that the political outcomes will change the direction of the US economy too much anyway, as the Federal Reserve yield much more power over the markets and economy.

Whilst it appeared two weeks ago that the USD would strengthen to below $1.1000 against the Euro, any gains were rapidly given back on the weaker US economic data. It now seems much more likely that the next US interest rate hike from the Fed will be in December, not at the 21 September meeting.

However, as has been stated previously in this column, the US dollar exchange rate should still strengthen to below $1.1000 against the Euro as the FX markets price the future today and the September or December Fed timing does not make a lot of difference.

Latest statements on the timing of a US rate increase from the voting Boston Federal Reserve President Eric Rosengren have encouraged the US dollar bulls yet again. At this point, an interest rate increase on 21 September would be a surprise to the markets, however stronger Federal Reserve rhetoric about a December increase will still be sufficient to push the US dollar currency value upwards.

The implications of US interest rate increases and a stronger US dollar in international currency markets over coming months are numerous (and generally negative) for the Kiwi dollar:-

  • Offshore hedge funds and real money funds who have been buying the Kiwi dollar and maintaining long Kiwi positions all year will start to unwind those positions once they see their well-earned currency profits reducing. The historical pattern of why the Kiwi dollar goes slowly up the escalator when it appreciates and then plummets down the elevator shaft when it depreciates is that these overseas fund managers continually fail to understand how small and illiquid the NZD/USD FX market really is. It is easy to come into the NZD slowly over time, however when they all rush the exit door at once the inevitable result is a plunging rate as daily market liquidity levels make it a rather narrow door.
  • Global share market volatility has been very low since the Brexit ructions in late June and the sanguine conditions have allowed consistent gains as equities still offer better returns than alternative investments. The previous market calm through July and August looks like it is coming to an abrupt end as the traditional September volatility is kicked off with the Eric Rosengren comments on interest rate increases. The Dow Jones Index was smashed down 394 points (2.1%) on Friday 9 September. Retreating global sharemarkets and rising market volatility drive the “risk-off” investor sentiment that is always negative for the Kiwi dollar.
  • The New Zealand sharemarket has continued to make spectacular gains this year as offshore buyers have increased their holdings from 30% of the market to over 45% market share. Profit-taking and falling global equity indices from here should cause those foreign portfolio investors to reduce their NZ holdings and correspondingly sell their NZ dollars as well.
  • A stronger US dollar on the global stage over coming weeks/months should see lower commodity prices as typically these prices move inversely to the US dollar value. However, the changing international supply/demand equation in dairy commodities is currently pushing our major commodity upwards. Lower metal and mining commodity prices will be negative for the Australian dollar against the USD (which the Kiwi follows) and maybe the dramatic rise in whole milk powder prices over recent weeks has been a little overdone.

Reserve Bank of New Zealand Governor, Graeme Wheeler certainly needs some luck to go his way with a stronger US dollar to take the heat out of the Kiwi dollar’s rise.

Over the last nine months the RBNZ have watched the Reserve Bank of Australia be much more aggressive on OCR interest rate reductions and the result is a stable AUD/USD rate in the mid 0.70’s, whereas the NZD/USD rate has appreciated 16% from 0.6400 to 0.7400.

The NZD/AUD cross-rate is up 8% from 0.9000 to 0.9700 as the Aussies have maintained their OCR 0.50% below ours.

The local financial markets are not expecting an RBNZ rate cut on the next review date on 21 September. However, if Mr Wheeler is really serious about needing a lower exchange rate to get inflation back within the 1% to 3% band, he should surprise the markets with a cut to get the FX traction he has long desired.

Timing is everything in forex markets. A surprise Fed hike on 21 September and a surprise RBNZ cut the next day would certainly push the Kiwi over the edge of the elevator shaft!

The RBNZ being predictable has made the Kiwi dollar a safe bet for the speculators this year. It is time for Mr Wheeler to take a leaf from the RBA playbook and to be far less predictable.

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Source: CoinDesk

 

Roger J Kerr contracts to PwC in the treasury advisory area. 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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2 Comments

The late August speech at Jackson Hole by Federal Reserve Chair Janet Yellen buoyed up the USD bulls as it was confirmed that economic conditions were aligning for another US interest rate increase in September or December.

I think not.

There is very little appetite for productive investment during depression because businesses realize very easily there is little return on investment under those conditions. Thus, economists believe low rates are incentivizing businesses to invest through the low costs of borrowing when in fact businesses refuse to borrow because as a matter of basic logic and common sense there is no reason for them to do so (at the margins) no matter how little it supposedly costs. It doesn't matter if you can borrow all you want at zero interest, if you think the economy is bad now and will remain that way you aren't going to add a liability that doesn't actually create expected wealth. The interest rate isn't the issue. That is a much different process than the one suspected of an R* at zero or negative.

It is, however, the opposite case for financial investment. Companies that experience depression in the real economy can be incentivized to participate in debt that flows entirely into financial progressions such as share repurchasing or M&A at greater and greater prices. These are, essentially, alternate outlets for resources because of the low reward paradigm in the depression economy, an almost paradoxical parallel to John Maynard Keynes' liquidity preferences. That has the effect of redirecting even more monetary flow via credit away from the real economy for distinct circulation outside of it. Productive investment creates jobs and incomes; financial investment creates unrealized gains and perhaps dividends. Despite the contention of economists (yet another correlation/causation fallacy disproven), there is no wealth effect from record stock prices leaving the economy further worse off (and creating a self-reinforcing spiral where less money to the economy creates more incentive to do even less in it).

Persistently low interest rates as well as productivity are symptoms of a depression economy. Economists and policymakers are being forced into that conclusion though they might be doing so for now on their own terms. Read more

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Willing a currency down , speaks of desperation. Roger states the RBA has been more aggressive in lowering the OCR compared to the RBNZ. over the past nine months. Could Roger expand on this , given his expert standing.

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