In his first column for 2022, Roger J Kerr assesses the three major forces driving the relative value of the NZD, and how they are likely to play out in the new year

Summary of key points:

• US dollar global currency direction in 2022.
• Aussie dollar to continue to dominate Kiwi dollar movements.
• New Zealand economy more likely to underperform in 2022.

As we enter a new year dominated by the “two’s”, 2022, we are reminded that even in foreign exchange markets there is always two sides to the story. For the NZD/USD exchange rate value and direction it has to be expected that the USD side of the equation will once again swamp and smother any local NZ influences.

However, the NZD/USD rate is also heavily influenced a third factor, the cold hard economic, investment and business reality that New Zealand is heavily dependent on Australia and where the Aussie dollar travels, we go with it (to a greater or lesser degree at times).

As exporters, importers and investors with assets denominated in foreign currency ponder their FX risk management and hedging strategies for the year ahead, their decisions to position hedging levels towards minimums or maximums of policy limits should be based on an assessment of the following three categories of themes and questions.

US dollar global currency direction in 2022

The US economy and the Fed’s actions: The dominant theme and question is whether the dramatic increases in the US inflation rate last year has already peaked and gradual improvements in the global shipping/supply chain situation allow supply of goods to catch up to the demand? Recent month’s US employment data has provided mixed signals as to whether the US economy has now reached full employment and thus the Fed need to remove monetary stimulus earlier and lift interest rates earlier. The number of new jobs in the Non-Farm Payroll labour market survey have been significantly below market forecasts in both November and December. However, the separate surveyed measure of the unemployment rate has recorded a sharp decrease to 3.90%. Labour shortages have forced annual wages increases above 5.0%, adding to the inflationary pressures from the demand side.

US bond and equity markets are now pricing in the first interest rate hike from the Fed in March, instead of June. Tellingly, the US dollar did not appreciate any further in the forex markets when the minutes of the Fed’s December meeting were released last week confirming that they are adopting a more hawkish stance on tightening monetary policy than what the markets were previously anticipating. Another sign that the FX markets have already fully priced-in US interest rate increases in 2022 and 2023 to the EUR/USD exchange rate at $1.1300.

Investment markets finally react to the candy being removed: Since mid-December the US bond and equity markets have belatedly reacted in an adverse fashion to the now more hawkish Fed. The inevitable equity investor profit-taking in over-hyped listed technology stocks is now occurring as money is no longer free. Likewise, treasury bond investors have also reacted in a delayed fashion to the higher inflation and upcoming  higher short-term interest rates. The 10-year bond yield jumping from 1.50% to nearly 1.80% over the last three weeks.

The conclusion from this latest market volatility is that cash proceeds from selling tech stocks is not going into the bond market, but back into industrials. Cryptocurrency markets have also taken fright alongside equity markets. Typically, the US dollar strengthens on safe-haven buying when equity markets fall, however in another sign that the US dollar bulls are exhausted, the EUR/USD rate has remained above $1.1300 over recent weeks.

Geo-political developments hit the oil market: Civil unrest in the world’s 9th largest oil producer, Kazakhstan, has driven oil prices up from US$65/barrel (WTI) in early December to US$80/barrel. The US dollar normally trades inversely to oil prices, so perhaps all the positives for the USD from the Fed have been outweighed by oil and therefore the US dollar has been unable to make any gains. In early resolution to this latest geo-political risk does not seem likely.

Aussie dollar to continue to dominate Kiwi dollar movements

All the positive factors and forces for the Australian dollar in 2022 listed in our 19 December column remain firmly in train i.e. imminent RBA change in stance, higher wages, commodity prices, superior GDP growth, the massive Balance of Payments surpluses and over-extended long-AUD speculative positions. The AUD/USD exchange rate has bounced around above and below 0.7200 over the Christmas holiday period. The rapid spread of the Omicron Covid variant through Australia may temporarily restrain the expected positive AUD sentiment. However, unlike the health-dominated NZ Government Covid policies, the Aussies balance health and economic factors and therefore refrain from smashing the economy with draconian lockdowns.

Australian economic data being released over coming weeks will feed into the RBA’s deliberations on monetary policy at their next meeting on February 4th. Overseas import/export trade and retail sales figures for November are due this week. Next week sees January consumer confidence and December employment, followed by their December quarter’s CPI inflation numbers on 25th January. All of the economic data will add to the picture that the RBA will be changing their tune on the need for and timing of interest rate increases.

The NZD/AUD cross-rate continues to decline, albeit in a jagged up and down manner. The NZD/AUD rate dipped below 0.9400 last week, depreciating a good three cents from 0.9700 in late September 2021 when we published our special FX report on the cross-rate. That report concluded with a firm view that the NZD/AUD was more likely to reverse direction to three cents (and more) lower than continue upwards to parity. Australia’s economic outperformance and their change in monetary policy to increasing interest rates (ours are already fully priced-into the NZD value) will continue to push the NZD/AUD rate lower in 2022.

New Zealand economy more likely to underperform in 2022

Pertinent questions on how the NZ economy will perform in 2022 and what that means for the NZ dollar value may be summarised as follows from the current vantage point: -

Consumer and property economy: Economic data (consumer confidence surveys) and anecdotal evidence (lower Xmas sales levels for The Warehouse) indicate that there was no pent-up spending bounce back from the August the December lockdown in the Auckland/Northland/Waikato regions. Household spending is subdued under the weight of mortgage/rent increases, higher fuel costs and much tighter credit conditions.

Evidence is also emerging that the inevitable slowdown in the residential property market is already happening.

It appears that the RBNZ have underestimated the rapid tightening in credit conditions in the economy, which is looming as a major problem for already financially stressed smaller businesses as they use their own houses for bank lending security. All adds up to GDP growth in 2022 being considerably below current RBNZ and bank forecasts. Adding to the risks is the distinct possibility that the Ardern Government’s only response to Omicron spreading in the community is to lockdown entire cities once again. It seems it is OK to allow into the country your DJ friend on multiple occasions and somehow exclude ICU nurses! Who says we don’t have corruption in New Zealand?

Export economy: Higher commodity prices and good currency hedging at lower NZD/USD levels helped exporter profitability in 2020 and 2021. The year ahead appears to be even more challenging with the Government providing absolutely no lead on when borders will have a staged re-opening.

However the largest challenge for exporters is securing reliable labour just to continue at current production levels, let alone increase them. Qualified and trained young Kiwi’s will be heading across the ditch at the first opportunity, exacerbating the labour resourcing issue. Bringing in skilled immigrants to provide the resources for the export economy grow is the answer, however the current Government’s immigration policy is headed in the opposite direction.

The net result is an under-performing NZ economy in 2022 and therefore the greater probability that the RBNZ will raise interest rates at a slower pace than current market pricing. However, a weaker USD globally will still push the NZD/USD rate back above 0.7000.

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