A “black swan” global risk event in the form of the rapidly spreading coronavirus pandemic has hit the Kiwi dollar very hard over this last week.
The NZD/USD rate has tumbled from above 0.6600 to 0.6460 as international investors revert to a “risk-off” mode and exit commodity and growth currencies like the AUD and NZD.
Businesspeople around the world, along with financial/investment market participants, are currently adopting a wait and see approach as to how this health crisis adversely impacts business decision making, trade flows, consumer spending and thus economic growth.
Risk events that damage the global economy are always negative for the Kiwi dollar.
The coronavirus situation is arguably doubly negative in today’s trading environment for the Kiwi and Aussie dollars as our economies are now so heavily dependent on the Chinese economy for investment and imports/exports.
As factory output in China slows up (due to closures and travel restrictions), the adverse economic fall-out has started and it is not positive.
It remains to be seen if the FX markets have over-reacted
The reaction by forex markets over this last week is understandable, the question is whether the NZD/USD rate continues to fall if the virus continues to spread across the world?
In some respects, the FX market immediately priced-in the worst-case scenario and further selling does not occur unless the events later unfold as being worse than the original expectation.
It is too early to judge whether the 1.5% depreciation in the Kiwi dollar over the last seven days has fully priced-in the full economic impact of the coronavirus or not.
Market commentators are making comparisons to the SARS virus event in March 2003 as a benchmark to how economies, share markets and currencies are impacted.
In March 2003 the NZD/USD exchange rate was trading at 0.5400 and by December 2003 the Kiwi dollar had appreciated to 0.7000 with no signs of the SARS risk event causing a sell-off in the currency at any stage.
Today’s situation is considerably different in that the Chinese economy as a proportion of the total global economy is now fourfold the 2003 level.
Therefore, if the Chinese economic sneezes there are far more ramifications for its trading partners.
On the other hand, the Chinese authorities have acted much quicker to contain and quarantine the virus than what occurred in 2003.
Australian hard commodity prices and New Zealand soft commodity prices have fallen over this last week as supply chains in China are disrupted and demand will be less.
Exporters advised to take hedging advantage from the unexpected sell-off
The coronavirus pandemic certainly upsets the strong NZ dollar recovery from below 0.6300 to above 0.6700 over recent months.
It comes at a time when very positive local factors for the currency, such as high export prices, government fiscal expansion (infrastructure spend-up) and low mortgage interest rates, would normally be pushing the Kiwi higher (all other things being equal).
The view of this column remains the same as it was for much of the second half of 2019, a value below 0.6500 has the Kiwi dollar undervalued based on its economic fundamentals, no matter what has caused the depreciation.
Local exporters should be taking advantage of this fortuitous and unexpected dip in the Kiwi dollar to cement-in attractive currency hedging levels.
Such decisions need to be based on an assumption that the coronavirus will be contained and controlled sooner or later.
The two factors that caused the NZ dollar depreciation to below 0.6300 last year, being the unnecessary 0.50% interest rate cut by the RBNZ and the trade wars, both proved to be not long-lasting or imparting permanent damage to the NZ economy and currency.
Similar analysis is justified with the current coronavirus “risk-off”, it is only a matter of time before the threat to the global economy starts to subside and markets restore their confidence.
We do not know the exact timing of when the current negative sentiment will reduce, however inevitably it does, and the Kiwi has plenty of room to recover.
The US dollar fails to make gains on the coronavirus crisis
What is instructive in the global foreign exchange markets over this past week is the fact the US dollar itself has not strengthened alongside other safe-haven investment flows into the Yen, Swiss France, US Treasury Bonds and gold.
The EUR/USD rate has returned to the mid-point of $1.1100 of its recent $1.1000 to $1.1200 trading range.
The central view remains that the US dollar will weaken against all currencies in 2020 based on relatively looser monetary policy settings and the massive expansion in the US internal budget deficit. President Donald Trump seems to want to provide further tax cuts to help his November re-election chances, which if announced will only add to the budget deficit (extending it to greater than 7% of GDP).
Positive NZ economic data could stop the rot
Looking ahead this week, there is a reasonable chance that positive local economic data will stabilise the Kiwi dollar and prevent further falls.
Whole milk powder prices are expected to record another 1.00% increase at the GDT auction Tuesday night. December quarter’s employment increase is forecast to be 0.40% which will reduce the unemployment rate to 4.1%.
A jobs number above +0.40% should prompt a slight rebound in the NZD/USD exchange rate. On Friday night US Non-farm Payrolls employment increase less than the 148,000-consensus forecast would be negative for the US dollar.
In summary, it appears to me that the Kiwi dollar has been caught in the backwash of global sentiment against anything connected to China.
We have largely followed the Aussie dollar down without any differentiation as to the coronavirus impact on the two respective economies.
China still needs to import food/protein to feed its people, therefore it is hard to see how the New Zealand economy is going to be that negatively impacted.
The key indicator to watch is the Yuan/USD exchange rate, which is currently at 6.9100.
The Chinese monetary authorities will not allow a weaker Yuan in this health crisis, they will keep it stable.
Therefore, we should see an end to the almost panic selling of the Kiwi dollar witnessed this week.
*Roger J Kerr is Executive Chairman of Barrington Treasury Services NZ Limited. He has written commentaries on the NZ dollar since 1981.