The coronavirus shock and the uncertainty surrounding the likely economic impact globally from the pandemic has dominated foreign exchange markets over this past week.
Not unexpectedly, the currency markets have sought out the safest place to be amongst the turmoil of not knowing whether this will just be a temporary event or something much wider and more severe on economic activity.
The US dollar continues to benefit at the expense of the AUD, NZD and many other currencies.
Whilst the daily rate of deaths from the disease may be starting to reduce in China there are very worrying reports of deaths spreading rapidly in countries such as South Korea, Iran and Japan.
The US dollar is the favoured currency as a safe-haven destination, the USD value continuing to strengthen against all currencies though February.
The Japanese Yen typically strengthens in such “risk-off” investor sentiment situations, however their proximity to China and weaker economic numbers already being reported has sent the Yen reeling to 112.00 against the USD from below 110.00.
Poor economic data has weighed on the Euro as well, the EUR/USD exchange rate has now dropped 3.5% from $1.1200 in early January to a low of $1.0800 during this last week.
The NZD has depreciated 6.5% from the high of 0.6735 at the start of January to a low of 0.6305 on 21 February.
The Kiwi dollar was already trading at a lower 0.6600 level in late January when the coronavirus news started to hit the currency value, therefore the NZ unit is down 4.5% on the reaction to the health/economic crisis.
The rationale for the forex markets to slam the AUD and NZD currencies in this environment is based on the large import/export trading relationship with China and the increased probability that our central banks may need to cut interest rates again to assist the economies to recover from the impact of the coronavirus.
It is far too early to make the call that additional monetary stimulus will be required, however the FX markets continue to price in the worst- case scenario.
It will require evidence that the virus is controlled and contained within China and elsewhere in the world before the currency markets will start to unwind their long USD positions against currencies such as the AUD and NZD.
The economic ramifications of Asia essentially being cut off from the rest of the world in terms of trade, travel and tourism are potentially very large and rightfully or not, New Zealand is directly affected due to our location and economic dependence on China.
An example of how financial and commodity markets are impacted is jet fuel prices plummeting 17% since January due to many airline flights being cancelled and demand substantially reducing.
NZ commodity prices fall less than others
Whole milk powder (“WMP”) dairy prices decreased by 2.5% to US$2,966/MT at the global dairy trade auction on 18 February.
Again, the reduction in the commodity price arguably much less than expected given the coronavirus circumstances.
Other commodities have fallen considerably further than the 9% drop in WMP prices since January.
WMP prices have returned to the US$2,950/MT level they fell away to in mid-2019, however subsequently bounced up from to over US$3,300/MT in November.
The drought climatic conditions in Northland and the Waikato will be reducing milk production and the resultant lower supply levels will act to support the WMP price over coming months.
The trading and economic uncertainties in China have directly impacted the volumes of logs being exported from New Zealand and local harvest activity is down 30% as a result.
Compounding the problem for the forestry industry is increased log imports into China from Germany where massive volumes of diseased Douglas fir trees are being cut down and shipped.
Coronavirus hits US services sector
The first signs that the coronavirus shock is adversely impacting on the US economy was reported on Friday 21 February with the IHS Market survey on service sector business activity falling in February for the first time since 2013.
The service sector survey includes finance, travel and retail components.
The Purchasing Manager’s Index plunged to 49.4 from 54.4 in January, causing US equities to fall and the US dollar to lose ground back to $1.0850 against the Euro.
The NZD/USD rate was able to recover to 0.6350 from the weaker US dollar trend.
Further weakening of consumer-related economic data in the US would be negative for the USD as the markets price-in the prospects of Fed interest rate cuts. It should be remembered that the retail/consumer part of the US economy has been driving all the recent economic growth with the manufacturing sector down due to Trump’s previous ill-advised import tariff policies.
The contraction in the US services sector (albeit just one months’ data) will be alarming to many economic forecasters and they will be hoping that the coronavirus is contained soon , so as to not create a US and global economic recession.
Kiwi dollar stays below long-term downtrend line
The reaction by FX markets to sell the Kiwi dollar down from 0.6600 to 0.6300 on the coronavirus event risk is understandable and perhaps justified as a knee-jerk response.
However, in my view, the NZD is again seriously under-valued at 0.6350 against its positive economic fundamentals that have not changed all that much over the last month.
On the proviso that there is progress on containing the epidemic over coming weeks, it would be no surprise to see a prompt unwinding of the short-sold NZD positions and a recovery back to 0.6500 and 0.6600.
When the NZD/USD rate traded above 0.6700 in the first few days of January 2020 it quickly reversed back down from the downtrend line (refer chart below) that has held in place since 0.8800 in July 2014.
My central thesis that the US dollar will weaken against all currencies in 2020 (due to their growing budget deficit and political risk) has been upset in the short-term by the coronavirus shock.
Events over the next month should tell us whether the economic impact from the epidemic is temporary (thus a Kiwi dollar bounce back up) or more permanent.
Currency values are relative prices and New Zealand’s “relative” economic performance and position has not been diminished is my reading of the current situation.
*Roger J Kerr is Executive Chairman of Barrington Treasury Services NZ Limited. He has written commentaries on the NZ dollar since 1981.