Roger J Kerr says those expecting the RBNZ to be more upbeat will be disappointed even though the string of good economic data extends. Those shorting the USD may be in for a nasty surprise

Summary of key points: -

• US dollar appreciating rally stymied (for the meantime)
• Kiwi dollar fails to react to positive economic data
• Markets expecting a more upbeat RBNZ will be disappointed

US dollar appreciating rally stymied (for the meantime)

A weaker than expected US January jobs report on Friday 5th February caused the US dollar, the Australian dollar and the New Zealand dollar to all pullback from breaking key levels in the foreign exchange markets. The US dollar strengthened last week to below $1.2000 against the struggling Euro, however the US employment data reversed its direction back to $1.2050 for the meantime. Likewise, the AUD was on the brink of falling below its key support level of 0.7575 last Friday but has rebounded to 0.7680 on the weaker USD against all currencies. The Kiwi appeared to be on track to trade below 0.7100 for the first time in over a month but has also reversed back to 0.7200. Movements of the US dollar on global FX markets continues to dominate the NZD/USD currency direction. After having raced up from 0.6600 in early November to a high of 0.7315 on 7 January, the Kiwi dollar has traded in a sideways pattern since, as the USD/EUR rate has flicked up and down between $1.2000 and $1.2350.

While many FX market commentators in the US are questioning whether the US dollar can continue its fledgling rally over the last month, the evidence is gathering that the US economy is about to recover at a much faster rate in 2021 than the European economy. While the number of new jobs created in January was disappointing (for the US dollar bulls) more forward looking economic indicators such as the ISM manufacturing survey point to a strong recovery. The Covid vaccine roll-out in the US appears much more organised under the Biden administration as action follows the decisions he makes. A stark contrast to the boasts, lies, accusations and personal attacks of his predecessor!

Over coming weeks I anticipate improving US economic data (aided by massive monetary and fiscal stimulus) to be positive for the US dollar and thus enable a more permanent movement below $1.2000 against the Euro. Speculative bets against the US dollar have been at record high levels over the last nine months and the USD depreciating to $1.2350 in early January was rewarding those short-sold USD position holders very well. However, the failure of the USD to weaken any further and the subsequent turnaround to $1.2000 will soon be testing stop-loss orders to exit those short-sold USD positions (i.e. USD buying). Highly leveraged speculation through currency options is adding to the risk of rapid movements in the rate as stop-loss orders are triggered. The sheer size of the USD speculative positions means that a clear break below $1.1950 in the EUR/USD rate over coming weeks could produce a much stronger USD to the $1.1600 area very quickly. A 3% appreciation of the USD against the Euro would send the NZD/USD rate to below 0.7000.

Kiwi dollar fails to react to positive economic data

It is very instructive to the future direction of the NZD/USD exchange rate that the NZD has failed to appreciate over recent weeks, despite three very favourable local economic developments that would normally send the currency higher, namely: -

• December quarter inflation increase of 0.50%, well above RBNZ forecasts.
• Unemployment rate dramatically decreasing to 4.9% in the December quarter against prior expectations of an increase to 5.6%.
• Whole milk powder dairy commodity prices increasing for the sixth GDT auction in a row since early November, climbing to a fouryear high of US$3,458/MT on 2 February.  

One explanation for the lack of response by the Kiwi dollar FX market to all these very favourable results was that all this “good news” was already priced-in to the NZD/USD rate via the jump from 0.6600 to 0.7300 in November/December. However that description does not wash, as the inflation and employment increases over the last two weeks were certainly not anticipated in advance back in November. The reality is that US dollar movements in the global currency markets is at this time totally dominating NZD/USD direction, variables influencing the NZD side of the currency pair are largely being ignored.

There has been no negative news for the NZD side of the exchange rate either as the NZ economy continues its “V” shaped recovery to the Covid shock 12 months ago. All the local economists who dismissed the possibility of a V-shaped bounce back in the economy last year have now become very bullish on the outlook and are now confidently predicting when the RBNZ will be forced to increase interest rates. In the writer’s view, they will all be wrong on that forecast as well!

Markets expecting a more upbeat RBNZ will be disappointed

The RBNZ may be forced to adjust their inflation forecasts for 2021 when they release their Monetary Policy Statement on 24th February, however that does not mean that they will be tapering back their monetary stimulus measures. If the financial markets are expecting the RBNZ to be less dovish in their economic prognosis and outlook in this statement, they may be sadly disappointed. The RBNZ are unlikely to move away from the stance that the economy has recovered due to their monetary policy actions to date and that they see no reason to reduce that level of support and stimulus. The economy still needs it. If they suddenly surprised everyone with a signal of interest rates increasing this year, the housing market would tank and that would cause more damage to the economy than allowing inflation to go above the 3.00% maximum limit. The RBNZ will still see several downside risks to the economy. The restrictions of likely border closures for most of this year being one.

A more accurate pointer as to the tone the RBNZ will deliver on 24th February was the decision by the Reserve Bank of Australia (RBA) to increase their bond buying/money printing (quantitative easing) amount a week ago. RBA Governor, Dr Philip Lowe stating that their wages growth would have to be materially higher to increase their inflation rate out of the 2% to 3% target range. They do not see their labour market improving to produce that wages lift until 2024. The RBA have just increased their monetary stimulus as the sharply higher AUD exchange rate has tightened monetary conditions more than they desire. The RBNZ’s current economic forecasts are based on a TWI exchange rate being 71.5 through 2021. The current TWI pushing close to 74.0 means that New Zealand’s monetary conditions are also currently much tighter than they want.

Watch for the RBNZ to deliver a very similar message to the RBA in two weeks’ time, which will send the Kiwi dollar lower as the markets have already positioned for the opposite. The December employment data shocked all and sundry with its strength, however it appears to be a rouge number and does not measure under-employment with many workers still on reduced weekly hours. According to the official jobs statistics 7,000 workers laid off in the travel/hospitality/tourism sectors were all re-deployed in the construction industry – I do not think so! The RBNZ will not be changing their current monetary policy stance due to this one seemingly positive number.   

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