Summary of key points: -
- Fed statement delivers a “one day wonder” reaction in the EUR/USD rate.
- GDP contraction underlines Government policy failure.
Fed statement delivers a “one day wonder” reaction in the EUR/USD rate
A sufficient number of participants in the global foreign exchange market clearly believed that the US Federal Reserve would signal the timing of interest rate increases in their FOMC statement last week.
The Fed was never going to do that.
However, such was the expectation that they would issue such messaging, the US dollar was immediately sold off when the Fed confirmed that interest rates would not change until 2023.
As a result of the US dollar selling and the EUR/USD rate jumping up to $1.2000 from $1.1900 last Thursday morning following the Fed’s statement, the NZD/USD spiked immediately higher to 0.7250 from 0.7150.
These US dollar inspired movements in the NZD/USD exchange rate caused the seemingly bizarre situation of the NZ dollar appreciating when the NZ economy surprisingly contracted by 1.00% in the December 2020 quarter.
The GDP figures were released mid-morning last Thursday after the earlier Fed release.
Typically, a shockingly bad result on the NZ economy, considerably worse than prior forecasts, would cause wholesale selling of the NZ dollar and a sharply lower currency value. However, we are not experiencing “normal” times and as this column has repeatedly stated over the last 12 months, the NZD/USD exchange rate is being completely dominated by the US dollar side of the equation. The NZD side continues to be ignored. There is absolutely no interest from offshore hedge funds and proprietary FX traders at investment banks to buy or sell the Kiwi dollar based on NZ economic, political or business news. Hence, no independent or separate selling of the Kiwi on the GDP growth outcome.
There was no appreciation of the NZD when dairy prices skyrocketed earlier this month and so far there is no NZD depreciation solely on the GDP contraction.
Within 24 hours of the US dollar being sold on the Fed statement, the EUR/USD rate had returned to $1.1900 and the NZD/USD reversing in direction as well, back to 0.7160.
It proved to be a “one day wonder” reaction.
Tellingly, the US bond market did not react at all to the Fed’s confirmation that short-term interest rates would not change until 2023. The 10-year US Treasury Bond yield remained at 1.64% on the day and his since increased to 1.72% as the bond market continues to price-in higher inflation and a stronger US economy. A continuation of US dollar gains against the Euro to the $1.1500 region seems inevitable over coming weeks given that US long-term interest rates are now more than 2.00% above those in Europe. Capital flows out of Europe into the US attracted by the higher yield returns will cause the USD to strengthen.
In addition to the interest rate differential, the other undeniably negative factor for the Euro is the third wave of Covid infections now hitting France, Germany and Italy as they were all too slow in distributing the vaccine. Weak European economic numbers will be the result at a time when the US economic outcomes are increasingly positive and strong. The contrast in economic performance between the US and Europe is likely to maintain the USD at a stronger level against the Euro for the next six months at least. An appreciation of the USD to $1.1500 from $1.1900 would pull the NZD/USD rate 3.5% lower to 0.6900. The probability of this NZ dollar pull-back, that we have been calling for, has moved up another notch due these recent development in the US and Europe.
GDP contraction underlines Government policy failure
The 1.00% decrease in economic activity in New Zealand in the December 2020 quarter was largely due to a significant slowdown in the industrial and infrastructure construction sector.
House construction continues at strong levels.
The Labour Government’s policy announcements in mid-2020 when the pandemic hit the economy was that “shovel-ready” Government financed infrastructure construction projects would replace the loss of economic activity in the tourism sector. It has not happened to date and does not look like happening anytime soon as local and central government bureaucracy stalls candidate infrastructure projects.
Shortages of equipment and qualified labour to do these projects compound the problem.
The Government’s repeated mantra on Covid and their economic policy response has been “go early, go hard, a good health outcome is the best economic outcome”.
It looks like a policy failure as the economy went backwards in 2020 and looks like it will also contract over the first half of 2021 as well.
Safe opportunities to help the economy over this period have been rejected and squandered by the Government, such as bringing in foreign students and RSE seasonal workers from the Pacific Islands.
The “abundance of caution” policies on Covid has been out of proportion to the risks.
The Australian Government has been far more balanced in their response and did bring in foreign students and seasonal workers under special controlled quarantine arrangements.
The local business community is now reflecting a growing frustration and impatience with Jacinda’s Government as they observe the Aussies always being a step ahead of us.
The Australian economy expanded by 3.2% in the December quarter.
Two weeks ago a number of business leaders petitioned our Government to open up to more transparency on their post-Covid economic recovery plans and offered to help.
The response from Jacinda and Grant was to... form a new committee! (business advisory committee to the Government).
In true Wellington form, the members of the committee are Rob Fyfe (who has been frustrated out of Wellington once before), Mr Fixit, Sir Brian Roche and two university academics.
The academics will be well meaning but they are just not at the coalface of business reality and the economy to advise on meaningful change.
More inspired choices would have been business leaders such as Don Braid of Mainfreight or Fraser Whineray of Fonterra.
At some point over coming weeks/months the flat to weaker local economic data will weigh on the Kiwi dollar in a generally stronger USD currency market environment.
The Government fiscal stimulus, monetary stimulus and consumer splurge last winter (spending of overseas holidays funds) that caused the V-shaped recovery is not being repeated this year.
There has to be disappointment that New Zealand’s seemingly adept handling of the Covid health/economic crisis has not materialised into a superior economic performance compared to others.
The economy needs new business investment, but that is also not happening as there remains too much uncertainty about the future, such as the Government locking-down entire cities for a week. There has to be a smarter way to deal with such risks.
*Roger J Kerr is Executive Chairman of Barrington Treasury Services NZ Limited. He has written commentaries on the NZ dollar since 1981.