Investment and financial markets around the world remain in a tailspin as fears compound about the potential economic and business consequences of the coronavirus shock.
As analysts and commentators struggle to measure and forecast the consequences, by far the best description of the current situation came from veteran Aussie retail king, Gerry Harvey of Harvey Norman fame, when asked for his view last week, his response was “who knows”. Whilst not very helpful or insightful advice for business folk facing currency management decisions, it was arguably a more accurate and honest assessment than most of the other pontifications in the daily media. It just remains too early to make clear judgements as to the magnitude of the adverse economic impact and for how long it will last. Hopefully, by the end of March the world will be in an improved position to judge the level and timing.
Against this backdrop of total uncertainty as to what the future holds, the financial and investment markets are voting with their feet in an almost panic reaction that appears to have gone too far already. I view the current situation of the NZ dollar’s value on the forex markets as different to what is occurring in global equity markets.
The Dow Jones Index is down 11% is this year as investors panic in a brutal sell-off. The NZD/USD exchanger rate has depreciated 7.5% from 0.6750 in early January to 0.6250 on Friday 28th February. Prior to the coronavirus event, US equity markets had been trading at extreme high values based on price earnings ratios. So, in many respects the 11% drop is removing a lot of froth in the market that was always susceptible to a catalyst causing a correction.
In the case of the NZ dollar, at 0.6750 it was a long way from being considered as over-valued based on economic fundamentals. Therefore, in a relative sense the five sent sell-off in the Kiwi dollar has been exaggerated as negative global events overshadow the more positive local economic factors.
Chinese economic capabilities being underestimated
Since the GFC over 10 years ago, many economic and market commentators have continuously made bold predictions that a debt/credit crisis in China would be the cause of a global economic downturn. That credit event risk has never eventuated as the Chinese authorities have always acted promptly with monetary and fiscal policies to cut off and prevent any contagion. Whilst many in the West question whether the Chinese authorities have the capability to control and contain the coronavirus today, my view is that the Chinese government has the financial resources and clout to prevent a major fall in their economy, jJust as they did in 2010 with massive fiscal stimulus packages to save both the Chinese and global economy from the ravages of the GFC. It may be remembered that the Australian economy experienced a mining boom in 2012 with the AUD/USD exchange going above $1.0000 because of the Chinese fiscal spending on infrastructure at the time.
If in doubt, paint three economic scenarios!
In a rather belated response to the rapidly evolving coronavirus situation, our Finance Minister Grant Robertson announced last week that the NZ government was in a good position, fiscal policy wise, to support the economy should the economic consequences deteriorate to a prolonged downturn.
Like many others, all the authorities can do is paint alternative scenarios of potential outcomes, assign probabilities to them and guess where we currently sit on the spectrum. Any money manager worth his/her salt developed such scenarios a month ago and already has portfolio protection measures in place.
The three scenarios are summarised as:-
- Scenario 1: Short-term/temporary economic hit with a rapid recovery (the “V” outcome).
- Scenario 2: Medium term hit to the economy, however an eventual recovery (the “U” outcome).
- Scenario 3: Prolonged and permanent economic recession (the “L” outcome”).
My reading of the current situation is that political and economic leaders see us somewhere between Scenario 1 and 2, whereas the equity, bond and currency markets are currently pricing a more extreme outcome between Scenario 2 and 3. It will require a reasonably rapid advancement to a vaccine to prevent and stop the spreading of the coronavirus to bring the financial/investment market over-reaction back to an economic outcome between Scenario 1 and 2. If that happens the NZD/USD exchange will pull out of its plunge lower and recover.
Again, the Western commentators do not believe a vaccine to control the coronavirus is possible within 12 months.
However, I would never under-estimate China’s ability to get things done much, much quicker than that. The Chinese testing methods used to get a workable vaccine may not be acceptable in the US and Europe, but the Chinese do not really care about that.
Kiwi dollar response to a weaker USD still to come
Forward interest rate market pricing in the US, Australia and New Zealand has already moved to expecting immediate monetary loosening with interest rate cuts. As the coronavirus event is both a “Biological shock” and “Supply-side shock” it is not all that clear how lower interest rates will help the economies.
If the potential economic downturn was solely caused by a collapse in demand, then an easing of monetary policy would be suitable to re-stimulate that demand. However, that is not the case here.
The fall in interest rates has been a factor causing the lower NZD/USD value until now. However, the US dollar itself has now reversed out of its strengthening trend against the Euro as US interest rates plummet, but Euroland rates stay stable. The EUR/USD exchange rate has reversed engines over the last two trading days from below $1.0800 to $1.1025 currently. We have yet to see any NZD/USD rate response to the weaker USD. The NZD/USD rate touched a multi-year low of 0.6191 on Friday 28th February, however, it has recovered somewhat to 0.6250.
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*Roger J Kerr is Executive Chairman of Barrington Treasury Services NZ Limited. He has written commentaries on the NZ dollar since 1981.