Roger J Kerr on 'bloody good news for NZ,', US non-farm payrolls & the likely currency impact of next week's expected RBA rate cut

"Bloody good news" on the New Zealand economy and a widely expected interest rate cut in Australia means the well signalled risk of the New Zealand dollar strengthening against its Australian counterpart has come to the fore this week, says PwC partner Roger J Kerr.

Kerr, who specialises in treasury management, also told interest.co.nz in a Double Shot interview that he expects to see figures showing strong new job growth in the United States when the US Labor Department's monthly non-farm payrolls data is released Friday night New Zealand time.

"I think we're going to see another reasonably strong number. In recent months they've been up between a 160,000 and 200,000 increase for the month," Kerr said.

"Consensus forecasts for this one are 185,000. From all the other data that feeds into these monthly employment numbers there's nothing to suggest it's going to be a weak number."

"In particular I was looking at some house building stats in the US the other day and they are the strongest they've been for five years. So it is happening at the household level in the US, and it looks like the jobs are there and the jobs are increasing," Kerr added.

"So I'd be more on the side that it's going to be a stronger number, towards 200,000, (rather) than say back at 150,000, which would probably be positive for the US dollar."

(Friday night's figures showed US payrolls rose by 162,000 in July, the least in four months, and the unemployment rate dropped to 7.4% from 7.6%).

Fed watch

The US employment market is particularly important right now in the context of the Federal Reserve's quantitative easing programme. The Fed's Federal Open Markets Committee (FOMC) announced this week it will continue to buy US$40 billion worth of mortgage back securities, plus US$45 billion worth of longer-term Treasury securities, every month as it strives to improve the performance of the US economy.

That's on top of US official interest rates, the federal funds rate, being held between 0 and 0.25%. The Fed says such low rates are appropriate whilst unemployment remains above 6.5%. The Fed's also watching inflation closely, and says current low interest rates will also remain appropriate so long as inflation in one to two year's time is projected to be no more than a half percentage point above its 2% longer-term goal.

Kerr described the FOMC statement as: "Very middle of the road, trying to placate all aspects and not send the market off on a tangent they (the Fed) don't want it to go in." That said, he suggested the statement did express concerns about mortgage rates.

Kerr noted that long-term interest rates, US Treasury bond yields, had risen since the FOMC's June statement to 2.6%.

"And that in turn determines their mortgage lending rates in the US. And he (Fed chairman Ben Bernanke) wouldn't like to see rising mortgage rates in the US at the consumer end of the market slowing down, or impacting negatively, on their (economic) recovery. So a bit of a slight warning there," said Kerr.

"As always how the markets move from here will be dependent on the data. So if we get strong employment or other economic numbers in the US, markets are going to start to build in an earlier tapering (of the Fed's quantitative easing programme).

Aussie rate cut 'looks inevitable'

Meanwhile, Kerr said both interest rate markets and foreign exchange markets in Australia and New Zealand have priced in a 25 basis points cash rate cut to 2.50% from the Reserve Bank of Australia next Tuesday, August 6. This comes after RBA Governor Glenn Stevens signalled in a speech the outlook for inflation meant there was scope for further rate cuts.

"The RBA do like to surprise the markets and do the opposite to what they expect, but I think next Tuesday they will cut," Kerr said. "That looks inevitable now."

"If anything it might be sell the Aussie dollar on the rumour, buy the fact. I would say it (a cut) is fully priced in and I wouldn't really expect the Aussie dollar to be thumped again in the forex markets like it has in the last couple of days," said Kerr. "It has come down from US92c to below US90c and that has pushed the (Kiwi-Aussie) cross rate up to almost A89c."

He said there was a lesson for New Zealand companies exposed to the Aussie- New Zealand exchange rate, in the form of exporters and New Zealand companies with substantial businesses in Australia who bring back their profits, if they hadn't hedged against the risk of the Kiwi dollar rising against its Aussie equivalent.

There had been signals for some time that the New Zealand dollar would go to A85c and higher, Kerr said, due to Aussie dollar weakness against the US greenback and the Kiwi being relatively stable.

"We've had some bloody good news in New Zealand in the last week, the Fonterra increased payout on the milksolids for the dairy farmers, business confidence staying at record highs. It's all very positive in New Zealand so Kiwi dollar stays stable against the US, Aussie goes down, (Kiwi-Aussie) cross rate up," said Kerr.

'OCR hike likely next March'

Kerr said he didn't see the statement issued by the Reserve Bank of New Zealand last week after its Official Cash Rate (OCR) review as a shift to more of a tightening bias, as some economists had. The OCR was left unchanged at 2.50%.

"I didn't really see it as a tightening bias. He (Reserve Bank Governor Graeme Wheeler) was stating the economy pretty much as we see it," said Kerr.

"The domestic economy is stronger, there are inflationary pressures coming from the housing market (and) the Reserve Bank have clearly increased their inflation forecast for next year, somewhere over 2%. It's very low at the moment but their job is to look ahead at what inflation's going to be in 12 to 18 months time and then manage monetary policy on the basis of that."

"So it still looks very much on that the OCR will be increased around March next year, and the markets are building that in already and quite justifiably," Kerr added.