If it were not for the event of the coronavirus epidemic adversely impacting on confidence in our financial markets, the Kiwi dollar would be riding a lot higher against the US dollar at this time.
The virus crisis is causing considerable uncertainty, particularly for an economy so heavily reliant on China for import/export trade and to some extent, tourism.
The Reserve Bank of New Zealand’s (“RBNZ”) monetary policy statement last week was a considerable seismic shift from their very dovish/negative outlook for the economy only a few short months ago in August 2019.
The RBNZ’s new assessment of our future economic performance was upbeat and much more positive on growth, inflation and investment than what the local financial markets were expecting.
Of course, there was a big qualification on the growth forecasts if the coronavirus impact proves to be more significant and prolonged than current estimates of only a temporary/short-term hit to the economy.
As this column has promoted for a long time, the RBNZ now also sees very low interest rates, high export commodity prices, the lower NZD/USD value helping exporters and the substantial Government fiscal impulse (infrastructure spending) as factors driving a higher GDP growth trajectory in 2020.
All other things being equal, that bullish economic prognosis would have driven the NZ dollar higher on the foreign exchange markets – and justifiably so. The NZ dollar did immediately jump up from below 0.6400 to a high of 0.6485 on the RBNZ’s announcement on 12 February, however the coronavirus uncertainties and a related stronger US dollar on global forex markets have prevented any further gains above that level.
The RBNZ have for the first time in a very long time included a forward forecast of the OCR interest rate increasing to 1.30% by December 2021 from the current 1.00% setting.
The more positive tone to the RBNZ’s statement is very much in line with the Reserve Bank of Australia’s monetary policy statement last week which caught the overly pessimistic markets and economists by surprise.
The belated recognition by both central banks that economic performance in 2019 was stronger than previously forecast and the outlook for 2020 is for stronger growth still, does suggest to me that both currency values are undervalued on a number of scores.
Last year it was the Sino-US trade wars and the prospect of lower interest rates that kept the NZD and AUD exchange rates lower than where economic fundamental variables suggested they should be.
So far this year it is the global risk event, the coronavirus pandemic that is artificially holding the currencies down.
For how long this inhibitor remains in place is not known with any certainty.
What we do know is that there will be an almighty catch-up of economic activity in the second quarter of 2020 if the impact is indeed only temporary as the RBNZ guesstimate.
Global FX markets see the coronavirus impact differently to equity markets
US equity markets have rallied higher over this last week, reflecting investor optimism that the economic impact of coronavirus will be short-lived and not disrupt company profitability or US GDP growth too much.
Equity markets also seem to be putting trust in the fact that centrals banks will cut interest rates to re-stimulate economic activity if the coronavirus impact proves to be more severe than currently estimated.
In contrast, FX, commodity and bond markets have taken different view with a stronger US dollar, stronger US treasury bonds and a sell-off in commodity prices on safe-haven flows from investors.
The strengthening of the USD to below $1.0850 against the Euro does appear to be an over-reaction.
The NZD/USD rate has not moved any lower as a result of this bout of USD strength.
However, any news that indicates that the spreading of the coronavirus is reducing in intensity may well see an unwinding of the long USD positions taken in currency markets over recent weeks.
A return of the EUR/USD exchange rate to the previous $1.1000 to $1.1200 trading range would allow the way for NZD gains back above 0.6600.
As expected, the Chinese have not allowed the Yuan/USD value to weaken above 7.0000 and they have pumped is massive amounts of liquidity into their markets to support the equity market in particular. The stabilising and underpinning of the Yuan’s value by the Chinese monetary authorities does also provide somewhat of a floor under the AUD and NZD values against the USD.
As the coronavirus economic impact plays out over coming weeks, my contention would be that the FX markets will quickly recognise that the NZD and AUD have been over-sold in the initial negative reaction to the outbreak of the virus pandemic two to three weeks ago.
The FX markets have been pricing in a worst-case scenario of the coronavirus hitting the economy for over eight months as the SARS virus did in 2003.
I would favour the RBNZ forecast and view that the coronavirus will only decrease our first quarter’s GDP growth by about 0.30% and that could easily be made up in subsequent quarters if the pandemic is contained and controlled.
Too early for NZ political risk to impact on dollar’s value
Whilst the run-up to the US Presidential election this November may potentially be negative for the US dollar’s value with Mr Trump likely to be buying votes with tax cuts that will blow out their budget deficit even further to dangerous levels, it difficult to see our general election campaign ahead of September being negative for the Kiwi dollar.
Global events and commodity prices will continue to be the major determinants of the NZD value and direction.
One interesting political development in New Zealand is the opposition National Party’s stated position on refusing to enter any coalition with the NZ First Party of Winston Peters, post the election result.
The implication is that a vote for NZ First is essentially a vote for a Labour Government, which will not please many NZ First supporters who like the leverage of Winston holding the balance of power and calling the shots after election day.
The challenge to the National Party is to convince the swinging voters in the middle that the current Labour Coalition government has delivered very little of its pre-election promises.
Should National continue to lead in the political opinion polls, the political risk for the Kiwi dollar seems more pointed to the upside, than the downside.
*Roger J Kerr is Executive Chairman of Barrington Treasury Services NZ Limited. He has written commentaries on the NZ dollar since 1981.