Opinion: Views on Aussie and US rate hikes to drive NZ$ this week

By Mike Jones The NZD drifted lower over the Easter break. In generally holiday-thinned trading, NZD/USD slipped from above 0.7080 on Thursday to around 0.7030. For the most part, it was a stronger USD that set the NZD/USD on a course southwards. While US non-farm payrolls looked a little weaker than market expectations (162,000 vs. 184,000 expected), the details of the report were anything but. In fact, nearly all the US data released since last Thursday has outstripped market expectations, underscoring analyst views of a rapidly improving US economy. Reflecting this sentiment, US bond yields have marched higher, underpinning broad-based gains in the USD. Not only did the NZD have the stronger USD to deal with, but the IMF said on Thursday “the currency is presently overvalued by 10-25 percent”. As a result, the NZD has tended to underperform many of its peers over the past few days. This was despite a relatively buoyant session for US equity markets and commodity prices overnight. The S&P500 is currently up around 0.8% from Thursday’s close, while the CRB index of global commodity prices rose just over 1% last night. We agree with the IMF that the NZD/USD is overvalued in a long-run sense. At current rates of US and NZ inflation, we estimate NZD/USD PPP “fair-value” to be around 0.6050. This means the currency is currently around 17% over-valued on this basis – bang in the middle of the IMF’s estimated range. However, this doesn’t mean a correction is likely anytime soon. Indeed, in a typical cycle, the NZD/USD spends 3-5 years “overvalued”, with the currency usually topping out 20-25% above its long-run “fair-value”. As such, we don’t see the long-run “overvalued” status of the currency as an impediment to the drift higher we expect in NZD/USD in coming months. If the monthly surveys are any guide, this morning’s QSBO will probably be a bit better than December’s good one, and so consistent with the firm economic recovery we forecast. Post QSBO, commodity price updates – in the form of Tuesday afternoon’s ANZ indices and Fonterra’s latest dairy product auction on Wednesday morning (NZT) – will provide another important test of ‘fundamental’ support for the NZD. But it is really this afternoon’s (4:30pm NZT) RBA interest rate decision that will set the early direction for the NZD this week. Opinion is still divided on whether the RBA will hike its cash rate to 4.25% or hold off until next month. Markets currently ascribe roughly a 60% chance of a 25 bps hike. If the RBA does raise rates, expect a knee-jerk spurt higher in NZD/USD, but with NZD/AUD likely to test 9½ year lows towards 0.7610. The USD has bounded higher over the Easter break, supported by a surge in US bond yields. Still, trading was fairly thin with most major markets (with the exception of the US and a few others) away on Friday and Monday. US non-farm payrolls was not quite as strong as markets had expected, at least in a headline sense. US employers added 162,000 jobs in March, compared to the 184,000 expected. But the fact the unemployment held steady at 9.7%, and February data was revised up to -14,000 (from -36,000), spurred optimism about the US economic recovery. The March US ISM manufacturing and non-manufacturing indices and February pending home sales were also on the stronger side of market expectations. US Treasury Geither did his bit for the positive mood, saying the US economy is “getting stronger” and “appears to be self-sustaining”. US 10-year bond yields surged from 3.86% on Friday to nearly 4% – the highest since October 2008. The supportive USD backdrop has seen USD/JPY soar to 8-month highs of nearly 94.80, while EUR/USD fell back to around 1.3500 from closer to 1.3580. Lingering concerns about whether Greece will be able to roll over its debts also provided a drag for EUR. The first large Greek bond maturity is due on April 13. US equities and commodity prices posted solid gains overnight, reflecting renewed optimism about the strength of the global recovery. The S&P500 is currently up 0.7%, while the CRB index (a broad measure of global commodity prices) jumped 1.1%. Oil prices reached US$86/barrel for the first time since October 2008. Against a backdrop of firm equities and increasing commodity prices, ‘growth-sensitive’ currencies like AUD and CAD found some respite from the stronger USD. In fact, CAD/USD dropped to within a whisker of parity with the USD (1.0010) for the first time since July 2008. Looking ahead, there is plenty of event risk to watch out for, despite the holiday-shortened week. Central banks are in focus with policy announcements from the Bank of Japan, Bank of England, ECB and the RBA all due this week. Only the RBA is expected to move interest rates – a 60% chance of a 25bps hike is currently priced in. Elsewhere, a host of Fed speakers will hopefully shed some light on what the recent improvement in the US economy means for Fed policy. Should Fed officials douse market expectations for early US rate hikes (the first is expected by November), we’d expect the USD to give back some of its recent gains. Watch out for any headlines from a FOMC meeting currently underway. A review of the Fed’s discount rate is on the agenda to be discussed. *All of the research produced by the BNZ Capital team of economists is available here