The forex market landscape and the outlook has changed dramatically for the Kiwi dollar over this past week.
Three developments; namely the US/China trade talks, the Fed’s handling of US interest rates and local GDP growth numbers, have combined to propel the NZ dollar sharply upwards from the 0.6500 low to 0.6590.
The three factors seem likely to generate further gains for the Kiwi dollar over coming weeks.
These forces are inter-related, as if the trade dispute is resolved, the global economic outlook will be more positive, which is very good news for the NZ economy.
If the trade talks fail once again, the global and thus the US economy will be weaker, and the Fed may need to be more aggressive with their interest rate reductions.
US/China trade negotiations
In an abrupt and bizarre turnaround from previous statements/threats over recent weeks, US President Donald Trump initiated a telephone call last week with Chinese Premier Xi Jinping in an attempt to get the US/China trade talks back on track.
The leaders of the world’s two largest economies will have an extended meeting at this week’s G20 meeting in Osaka, Japan.
Additionally, the US and Chinese trade negotiators will meet beforehand to obviously address the problem areas that caused the talks to completely break down last month.
One reading of why Trump would suddenly change his stance and attitude towards the Chinese is that recent political opinion polls in the US have recorded falling support for his re-election next year due the tariffs and threats of tariffs damaging the US economy.
More than anything else, Trump is motivated by his own popularity as the saviour of the US economy.
He may have finally realised that a disruptive and prolonged trade war would be negative for his re-election chances. Hence the olive branch to the Chinese to re-commence the trade talks.
Another interpretation of the desire to meet and make progress on the trade talks is that there have already been concessions and compromises made between the parties, as it is unlikely that Trump and Xi would have agreed to an extended meeting in Japan unless they could both stand up at the conclusion of the G20 and grandstand a truce and a pathway to a trade agreement.
Both leaders would not have agreed to the meeting if there was a chance of another bust-up. Something positive has happened in this respect that we have not been told about.
The financial markets would certainly respond to positive progress in resolving the trade wars by buying the NZD and AUD. Both currencies have been sold-off over the last 12 months as a world of retaliatory tariffs reduces export market access and global demand – both bad news for export economies such as ours.
US interest rates
The US Federal Reserve’s FOMC meeting last week has seemingly paved the way to for interest rate cuts over coming months as inflation continues to track below target and other economic indicators soften.
There is no question that the trade/tariff dispute has reduced business confidence and investment in the US, and this is now coming through in the official economic data.
The US employment market has been strong to date, however the much lower than expected 75,000 increase in jobs during May could have signalled a turning point as business firms hold back on expansion plans.
Another two months of weaker employment growth will certainly convince the Fed to ease monetary policy by cutting interest rates.
The Fed did deliver to prior market expectations with the tone and change of wording in their meeting statement.
The US dollar has weakened since the Fed meeting, losing considerable ground against the Euro from below $1.1200 a week ago to $1.1370 at the time of publication.
Lower US interest rates are negative for the US dollar and many see it reversing out of its strength over the last two years, a period when US interest rates were expected to increase or were increasing.
The EUR/USD exchange rate has now more convincingly broken out of the downtrend line the Euro has remained below since $1.1800 a year ago. Further Euro strength/US dollar weakness appears likely from here, particularly if the G20 meeting delivers progress on the trade talks.
New Zealand GDP growth
The standout feature of the GDP growth figures for the March quarter released last week was what was not in the numbers.
The large and dominant primary and services sectors were both flat over the quarter due to weather conditions and a slowing real estate market.
If the New Zealand economy can expand by 0.60% over a quarter without agriculture, forestry and fishing increasing, it does suggest there is an underlying strength that augurs well for the future.
The Kiwi dollar jumped up on the result as it was above consensus forecasts of +0.50% and well above the +0.40% RBNZ forecast.
Looking ahead, agriculture, horticulture and forestry sectors are all enjoying favourable commodity prices, therefore production can be expected to increase a lot more than what was seen in the March quarter. An annual growth rate of +2.50% for our economy (although lower than the 3.50% increases of recent years) is still relatively impressive measured against everyone else and amidst a global environment of trade/tariff uncertainty.
Local exporters have had another bite of the cherry to load-up on forward hedging at 0.6500. Those exporters waiting for the lower 0.6200/0.6300 levels forecast by some banks (which can only be based on a forecast stronger US dollar value) may have to re-assess their strategy as the USD itself has started to head the other way.
*Roger J Kerr is Executive Chairman of Barrington Treasury Services NZ Limited. He has written commentaries on the NZ dollar since 1981.