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Roger J Kerr points out where the US dollar is heading, seeing a stronger period ahead. He also sees cracks appearing in overstretched speculative markets

Currencies
Roger J Kerr points out where the US dollar is heading, seeing a stronger period ahead. He also sees cracks appearing in overstretched speculative markets

Summary of key points: -

  • US bond yield direction key for the US dollar’s next move
  • Much more to come on stronger US economic data
  • New Zealand managing to make itself unattractive for foreign investors
  • Cracks appearing in over-extended speculative markets  

US bond yield direction key for the US dollar’s next move

Judging the likely future direction of exchange rates is not only about forming a view on the relative performance of the two respective economies; it is also a fair part of judging whether the currency markets have already priced-in the timing of one economy outperforming another.

The question as to whether the recent weakness in the US dollar (moving from $1.1800 to $1.2100 against the Euro) is temporary or permanent is important in concluding whether the NZD/USD rate can return to below 0.7000 from 0.7200. These recent US dollar falls do not appear to be a result of a sudden realisation by the markets that European economic data is about to outperform the US economy.

The USD sell-off is more related to a natural correction downwards in US 10-year Treasury Bond yields from a high of 1.77% at the end of March to 1.56% today.

The US dollar made strong advances against the Euro through February and March from $1.2300 to below $1.1800 on the back of the sharp rise in the US long-term bond yields from 1.00% to 1.77%. The 2.00% yield return advantage in investing in US bonds at 1.77% over European bonds at -0.30% being a driving factor in the movement of funds out of the Euro into USD’s. The subsequent downward correction in the US bond yield appears to be only temporary as some market traders take profits on their short-sold bond positions following the rapid climb in yields to 1.77%.

Upcoming releases of US economic data (particularly their employment numbers on Friday 7th May) are expected to be very strong and reverse the direction of the 10-year bond yields to upwards again. It will only take higher than expected US inflation or economic activity data to spark another bout of bond selling, shifting the yields higher and therefore USD appreciation.

Much more to come on stronger US economic data

A number of currency market commentators and analysts are suggesting that US dollar will continue to weaken against the Euro as the dramatic improvement in the US economy on the Covid vaccine roll-out has already peaked and FX markets are looking ahead to European improvement.

Such expectations are premature in the writer’s opinion, with the return of the USA to jobs, travel and spending over the last month yet to be fully reflected in their economic data.

The Euro posted gains from $1.2000 to $1.2100 on Friday 23 April following a stronger manufacturing survey result of 53.7, a nine-month high. In contrast, the US manufacturing index is well above 60! The latest gains by the Euro are forecast to be short-lived as upcoming US economic data will all print on the stronger side and prove to the markets that the current US economic recovery is far from peaking.

There is much more to come on the US economic recovery front over coming months, therefore a return to the US dollar strengthening trend is a higher probability.  

US GDP growth figures for the March quarter due for release on Thursday 29 April may well be above the annualised +6.3% that is forecast. Such an outcome would certainly strengthen the US dollar. There should be no surprises from the Federal Reserve meeting on Wednesday 28th with Chairman Jerome Powell acknowledging the rapid economic rebound, however providing no hint as to when all their monetary stimulus will start to be unwound.

There should be absolutely no expectation in the forex markets that the Fed will signal tapering of their bond buying/money printing anytime soon.

New Zealand managing to make itself unattractive for foreign investors

Building a picture of anticipated EUR/USD exchange rate movements from current levels is critical to forming a view on near-term NZD/USD direction. Global currency movements continue to dominate the Kiwi dollar’s fortunes with local New Zealand economic, political and financial market influences very much taking a back seat at present.

However, at some point the international investment community will be examining how New Zealand is doing in the post-Covid era relative to others. After all the positive publicity New Zealand received last year with keeping the deadly pandemic out and staging a spectacular “V-shaped” economic recovery in the third quarter 2020, the offshore players may be disheartened to observe that we are likely headed for a double-dip recession in early 2021. The March quarter GDP results are not released until late June, however many of the lead-indicators for the economy are all sagging into a very flat performance over the first half of 2021. Local business investment and confidence is turning down again as it is realised that the Government has no real plan for re-opening the borders to allow much needed skilled workers to come in or re-invigorating the economy with innovative policy prescriptions.

Unfortunately, the current image being projected to potential foreign investors into the NZ economy is not all that attractive: -

  • The Government cannot be trusted as they have shown they change economic policy overnight without consultation (oil and gas exploration ban and tax deductibility on residential investment property).
  • Intervention and interference by the Government is increasing as seen with the Finance Ministers “directions” letter to the Board of Air New Zealand and a reduction in the RBNZ’s independence with the Government legislating their power over the RBNZ on bank lending regulations.
  • The extreme time delays for foreign buyers to obtain Overseas Investment Office approvals is also a major frustration and disgrace.

At a time when we should be promoting ourselves internationally as an attractive and safe place to do business, we appear to be shooting ourselves in the foot as a left-leaning Government displays its true colours of insular ideology. The previous confidence from foreign direct investors and offshore investors into our equities and bond markets about New Zealand’s independent institutions and consistent policies is being eroded away and that cannot be positive for the NZ dollar outlook.

Cracks appearing in over-extended speculative markets  

Cracks are starting to appear in the thin veneer across the many investment bubbles that have expanded since interest rates were slashed to zero around the world 12 months ago. The Archegos hedge fund scandal that severely dented big bank reputations, the Greensill Capital trade finance fund that went bust, and now cryptocurrency exchanges falling over - all point to excesses that just become unsustainable and simply implode on themselves.

How much longer is it until we see a similar shake-out in the speculative part of the commodities markets that have driven prices sky high over the last six months?

Iron ore price (which are influential on the AUD/USD exchange rate) hit a new 10-year high on 22 April of US$188 per tonne. The Chinese authorities will be concerned at these higher prices as they announced environmental controls over their steel production regions and were anticipating lower demand, not more! The extreme iron ore demand/supply imbalance that has propelled the prices higher over the first four months of 2021 should abate over coming months as the Chinese act and the Brazilian Vale iron ore mine ramps up production again.

It is looking like a complete miss-match between New Zealand and Australia on the economic performance stakes over coming months.

Australia is in another mining boom and posting positive economic growth, New Zealand is wallowing in uncertainty and frustrating shortages of goods and skilled workers.

Therefore, clearly no reason for the NZD to be outperforming the AUD against the USD and pushing the NZD/AUD cross-rate up to 0.9300.

Watch for an unwinding of these movements and the NZD under-performing the AUD from here.

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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.

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19 Comments

One could interpret this differently ...
"Unfortunately, the current image being projected to potential foreign investors into the NZ economy is not all that attractive: -
"The Government cannot be trusted as they have shown they change economic policy overnight without consultation (oil and gas exploration ban and tax deductibility on residential investment property)."

... as the government doing what it promised to do by taking seriously climate change and (belatedly) tilting the home ownership playing field back towards citizens rather than investors/speculators.

If foreign investors don't like a government prioritising its citizens needs maybe we don't want their investment ('farming' of our people) ...?

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Problem being that our economy has been totally outsourced to the point where we have no option but to accept foreign investment to maintain our standard of living. Free trade was never “free”. The 1% got richer while the 99% are left holding the bag

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Antz, there is a country that doesn't attract any foreign investment (which you say is desirable), it's North Korea

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North Korea has way more issues than not attracting foreign investment!

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Stopping oil and gas exploration doesn't help the climate. That fuel will be found somewhere, probably where processes are less clean. It will then need to be transported here.

Short term virtue signaling. Practically this governments slogan.

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Yes, it seems a very strange ideological rant from Kerr. His reasons:

1. A decision a few years past to curtail new permits for oil exploration but not existing activity. What short term impact now from a decision years in the past?

2. Pressuring the resevere bank to stabilise the property market and banking sector. Plus OIO approvals...And Kerr implies this stuff is having a major off-putting effect on foreign investment? Seems like he's implying an awful lot of foreign investment is only in property / land speculation.

Is that really all NZ has to offer, selling the family silverware? What's up with this apparent ideology of wanting to sell NZ out from under Kiwis?

Moreover, we in my industry have brought in multiple skilled workers over the last year. Actual skilled workers, not hospitality / horti wage slaves.

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Roger Kerr once again states it quite clearly. New Zealand's left government will drive away foreign investment at a time it is badly needed. Kiwis will only realize what a mess the current government is creating once the economic impact begins to be felt. By then it will be too late to repair much of the damage.

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Damage was done decades ago when we decided to trade our own long term stability for the sake of quick profits.

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Really? My business is booming..

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Everyone relax. Someblokes business is booming..

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Really? My business is booming..

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If it's only selling off NZ land to foreign ownership - which seems to have generally been the right-leaning parties' plan - of what benefit is that to younger generations of Kiwis? Seems like an aged, bankrupt ideology.

Meanwhile, we have the likes of Microsoft and others investing in actual business in NZ, not just land speculation as Kerr implicitly refers to here. Perhaps we don't need to sell NZ out from under Kiwis to actually get investment in real business, rather than pretendy business.

The problem is we've not had a government in recent years actually interested in encouraging real, productive business by improving its attractiveness relative to property. They've simply abandoned that and focused on selling NZ off for a quick buck. If we really want to encourage business let's drop our company tax rate to 5% and pick up the slack with land value tax.

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The naivety of both national and labour governments in the face of the global power play is jaw dropping. It really is fools and against PHDs. We have walked into the debt and trade diplomacy trap as if we were zombies. We have taken the divide and conquer bait like lab has its dinner and will soon be peeled off from our five eyes partners,,, just like the Phillipines in the south China sea. Quiet for so long it is now too late.

Hope everyone is happy sipping their filthy lucre funded lattes, when the militia come fishing in the Hauraki gulf. The day is coming and NZ will be powerless to stop it. We have already been bought and invaded.

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The section on foreign investment seems somewhat narrow minded.

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USA economy staging a recovery as a result of... economic policy changes overnight without consultation, large scale intervention and interference by the Government, tight control of external interests in its economy.

NZ a complete no hoper because of, errrrm, exactly the same.

The 'blind belief in the free market' era is over. Get used to it.

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and now cryptocurrency exchanges falling over

Not correct. Punters leveraged on long positions 'fell over.' The markets haven't fallen over. The cleansing of the market is a good thing. No bailouts.

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I too was questioning what he was on about with that comment. Nothing has fallen over as far as I have heard. Over leveraged positions getting wiped is great for the bull market. Onwards to the next phase. If we can breach this 53-55k resistance I recon 75k+ in the next 2 weeks.

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This is claptrap. In the face of crisis, Kerr is urging we double down on the status quo. To remain naively optimistic free-market ideologues when the world is turning insular is like unilaterally disarming yourself in the midst of a global war.

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