The Kiwi dollar continues with its recovery against the US dollar, climbing off the floor at 0.6500 reached two weeks ago to trade back to 0.6665.
Perceptions of future interest rate movements have aided the sentiment and direction of the Kiwi on two fronts: -
- Locally, the FX market received a surprise on Wednesday 5th June when a speech by RBNZ Assistant Governor, Christian Hawkesby to the Japanese Institute for Monetary and Economic Studies in Tokyo indicated that the RBNZ was happy with where interest rates currently sit. Previous market pricing was that the RBNZ was on a clear dovish bias to further rate cuts. The NZD/USD rate jumped up from below 0.6600 at the start of the day to above 0.6640. Questions are being asked of the RBNZ as to why a speech made by one of their Assistant Governors in Tokyo on May 30th was not posted on the RBNZ website until the 5th of June. There were clearly no FX folk at the 30th May Tokyo event!
- Interest rate market pricing in the US has changed dramatically in recent months. Back in December the short-term interest rate market was pricing-in three 0.25% interest rate hikes for 2019. That changed to no increases in January when Federal Reserve Governor, Jerome Powell hinted in a speech that economic growth and inflation factors meant interest rate increases may not be necessary. In reality, he was worried about the impact on the US economy from a tumbling equity market at the time. Fast-forward to early June and the rhetoric from the Fed has shifted again to stating that they will be prepared to cut interest rates if the economic conditions/outlook warranted it. The US dollar was strengthening against the major currencies over recent weeks due to the escalation of the China/US trade wars, however it has now started to lose ground on the now lower US interest rate outlook.
Weaker US economic data hurts the US dollar
On top of the 180 degrees about-turn by the US Fed since the start of the year, the US dollar is also now under further downward pressure in the markets from weaker US economic data.
The ISM manufacturing index has turned down sharply in recent months as manufacturing companies hold back from output expansion plans as a result of the uncertainty surrounding tariffs and the trade wars.
In addition, the US tariffs on imports from China introduced by President Trump have already increased the cost of componentry parts for US manufacturers.
Up until the month of May, US employment increases had remained strong, averaging above 200,000 new jobs every month, however the May result released on Friday 7th June was a very weak 75,000 increase (well below prior market forecasts of +180,000). The EUR/USD exchange rate moved up (weaker USD) from $1.1130 on 30th May to $1.1330 after the poor US jobs data.
Relative value and relative safety
Against this international backdrop of elevated economic uncertainty due to the trade wars, new concerns about US economic performance reflected in their interest rate markets and investor reluctance about Europe due to deteriorating industrial production levels in Germany, the NZ economy and the Kiwi dollar start to appear as a bastions of relative safety.
It always should be remembered that exchange rates are relative prices.
Whilst many local commentators constantly predict the demise of the NZ economy due to Auckland house prices no longer increasing, our relative performance against what is happening in the rest of the world is pretty good.
GDP growth numbers for the March quarter to be released on 20th June will provide an indication on how we are tracking in 2019. A strong export trade performance by our major industries of dairy, meat and horticulture suggests an expansion above +0.50% in the March quarter.
Revival of the commodity currencies?
The view of this column for some time has been that the US dollar will not sustain its strength against all currencies that it has displayed over the last two years.
On top of the major negative of the massive increase in the US internal Government budget deficit (due to Trump’s tax cuts in 2017), the US dollar is becoming even less attractive with the now lower interest rate situation.
Global fund managers and hedge funds will be reducing USD holdings and speculative bets for a stronger US dollar.
The Aussie and Kiwi dollar are coming off cyclical low-points, therefore international funds seeking safety in currencies other than the USD, Euro, GBP and Japanese Yen may well be looking our way.
Both the NZD and AUD are arguably under-valued at current levels against their respective commodity price indices.
Global investors and hedge funds have always regarded the antipodean currencies as “commodity currencies” due to the close correlation to our major export commodity prices.
Over recent months the NZD/USD and AUD/USD exchange rates have significantly diverged away from the higher commodity price trends due to interest rate cuts by the RBNZ and RBA. The interest rate negative in front of the forex markets has now reduced in intensity as the expected cuts have been delivered.
The escalation of the trade wars between China and the US over the last month have been a negative for the NZD and AUD exchange rates as we are trading economies heavily dependent upon China. That negative factor may well start to reduce over coming weeks/months for the following two reasons: -
- The People’s Bank of China (PBOC) have confirmed that they are prepared and have the firepower to stimulate their economy through monetary policy if they need to as a result of the trade wars.
- President Trump more than anything else wants to be re-elected in 2020. He needs a strong US economy to enhance his chances, otherwise he is a rejected one-term President. As a result, Trump is coming under enormous pressure from the US economy and the financial markets to resolve the trade dispute with China sooner rather than later.
When a US/China trade agreement inevitably and eventually happens (maybe now six months away), the NZD and AUD exchange rates will be rated higher. Currency markets always price-in future probabilities well in advance, therefore further NZD gains to 0.6700 and 0.6800 seem more likely than selling below 0.6600 over the next few months.
Stronger USD trend against the Euro now broken
Over the last 12 months the EUR/USD exchange rate has remained below the trend-line in the chart below. Recent USD weakness to above $1.1300 against the Euro has broken out of the trend to the top side. Chart based trading could lead to further USD selling.
*Roger J Kerr is Executive Chairman of Barrington Treasury Services NZ Limited. He has written commentaries on the NZ dollar since 1981.