Roger J Kerr says while many commentators continue to be negative on the outlook for the NZ economy, the picture changes dramatically if China and the US can settle a trade agreement

The Kiwi dollar has held its ground at 0.6300 against the USD, despite further US dollar strength globally over recent weeks.

The USD gains due to increased geo-political tensions in the Middle East and general “risk-off” sentiment in investment markets as a result of continuing Brexit shenanigans and impeachment proceedings against President Trump.

Weak economic data in Europe with the German economy heading for recession has weighed on the value of the Euro currency and thus has prevented the USD dollar from losing ground due to US interest rate cuts.

The EUR/USD rate has traded to a low of $1.0900 from previous levels around $1.1100.

Over the last week the Kiwi dollar has outperformed other currencies against the USD, resulting in the cross-rates against the Aussie dollar, Yen, Pound Sterling and Euro all lifting off their low points of two weeks ago.

There may be signs that the speculative Kiwi dollar selling (that drove the NZD/USD rate to below 0.6300 after the surprise 0.50% OCR interest rate cut in early August) is becoming exhausted as the punters are not prepared to add to their short-sold NZD positions at these levels. However, we have not had any particular positive news or developments to encourage sustained NZ dollar buying.

Lower business confidence will not be positive for the Kiwi

Whilst local business confidence has been depressed for some time now, releases of the monthly ANZ and quarterly NZIER business confidence measures on Monday 30th September and Tuesday 1st October respectively, are likely to send the Kiwi temporarily lower as the sentiment indices sink lower again.

The latest Rabobank farming confidence survey was also sharply lower despite sheep meat prices being at record highs.

Many farmers obviously feeling singled out and under attack from the Government with water and carbon emissions policies.

The ongoing saga of the trade wars between China and the US is also eroding local business confidence and business investment.

However, to be frank the New Zealand economy has not suffered any widespread negative impact from this over the last 12 months.

Manufacturing activity and forward orders are certainly lower as measured by the PMI index, being the one area of the NZ economy that the uncertainty of the trade wars has impacted negatively with expansion on hold and supply chains disrupted globally.

A trade deal is still possible

There have been too many false starts of progress towards a trade agreement between China and the US over recent months to have any great confidence that the next scheduled meeting on 10th October will be any different.

However, falling consumer confidence levels in the US will be reminding Donald Trump and his trade negotiators that the tariffs are hurting the US economy as much as being detrimental to parts of the Chinese economy.

The motivation of both sides to reach agreement on the sticky points of technology transfer and intellectual property ownership must higher today than ever before.

Another low monthly US employment figure on Friday 4th October (a jobs increase less than 140,000) will be further evidence to the Trump camp that the tariffs are weakening the US economy.

The probability of the US economy sliding into recession is still hotly debated, however Trump will be under increasing pressure to do a deal with the Chinese to reduce the economic recession risk.

The view that both the NZ dollar and Aussie dollar will appreciate on any sort of positive progress towards a trade agreement still holds as a lot of uncertainty in the world would be lifted.

Lower Aussie interest rates already built into the AUD/USD exchange rate

The Reserve Bank of Australia is expected to cut their interest rates by another 0.25% to 0.75% on Tuesday 1st October as they continue to see their unemployment rate of 5.3% as well above their target of 4.5%.

Current economic trends in Australia would suggest that their unemployment rate will reduce over coming months, however there is always a substantial time lag form a pick-up in activity to more permanent jobs flowing.

At levels between 0.6750 and 0.6800 the AUD/USD exchange rate has already priced-in the interest rate decrease, therefore the FX market focus will be on the RBA’s future guidance on how many more rate reductions will be required.

The improvement in the Aussie economy over recent months does suggest that the RBA will not be as bearish on the outlook as they have been previously. The AUD/USD rate has stabilised over recent weeks and further depreciation as a result of the OCR cut is not expected.

Very positive NZ economic conditions if a trade deal can be agreed

Whilst many commentators continue to be negative on the outlook for the NZ economy, the picture changes dramatically if China and the US can settle a trade agreement.

The economic conditions are already very favourable with high export commodity prices, super low interest rates, a much lower currency value and the Government in a healthy financial position to expand fiscal policy.

Business confidence and investment would turn around sharply when the cloud that is the trade wars is lifted.

Under that scenario the outlook for the Kiwi Dollar also become much more positive.

*Roger J Kerr is Executive Chairman of Barrington Treasury Services NZ Limited. He has written commentaries on the NZ dollar since 1981.