By Roger J Kerr
Disappointing data from China's manufacturing sector last week has cast a shadow over global markets, triggering a sell-off on Wall Street and in Emerging Market currencies.
The Kiwi dollar has been sold down by over a cent and for the first time in a number of weeks, the NZD/USD exchange rate has actually followed the AUD/USD rate lower.
Global investor risk appetites have been turned towards the “off” direction as they worry about China and the candy being removed by the Federal Reserve.
The year started positively for investment markets (thus the Kiwi dollar) as the self-sustaining global economic recovery gathers some momentum.
However, a month into the year the previous uncertainties surrounding China and Emerging Markets (Turkey, Argentina, Russia, Thailand and South Africa) have re-emerged and risk aversion is starting to gripe once again.
I have always taken the view that even if there some banking/credit related problems internally in China, the knock-on impact on the global economy and financial/investment markets would be limited as Beijing has massive financial reserves available to it to shore up any domestic contagion.
The credit spreads of Chinese Government bonds and Chinese banks have increased sharply by 0.25% since 1 January 2014 which tells you that the risks are real.
The sell-off in equities last week followed a much lower than expected Chinese monthly manufacturing PMI and the market reaction was that perhaps Western demand for Chinese manufactured product was not as strong as many thought.
The Chinese and Emerging Markets risks, coupled with the US Federal Reserve continuing down the QE taper road this week, have markets/currency investors sufficiently on edge to dissuade them from adding to exotic currency positions like the NZ dollar.
A continuation in the NZD/USD pull-back seems likely and further short-term NZD selling should come from disappointment by some that the RBNZ do not increase the OCR on Thursday.
RBNZ Governor Wheeler should conclude that the TWI at 78.0, global financial instability and LVR’s slowing activity in the domestic housing market will be enough to leave any consideration of OCR adjustment until March.
Watch for the NZD to be sold down below 0.8200, probably before the OCR review on Thursday as long-Kiwi position holders hedge their bets.
Governor Wheeler will also be conscious not to do anything to send the Kiwi dollar even higher against the AUD, which is already at eight-year highs of 0.9430.
Investors seeking to diversify their portfolios into Australia and international markets should be taking advantage of the great NZD buying power against the AUD currently.
Likewise, those of us who work for a living and need overseas holidays, the deals have never been cheaper into Asia, the US and Australia. A booming economy that helps to deliver a strong currency does have some advantages.
Thinking about whether the NZD/AUD cross-rate is sustainable at 0.9400 is not just about the differential in the two interest rates that points to a more realistic 0.8900 rate, it is also whether New Zealand really has gained 20% on Australia in economic performance over the last 12 months. An examination of wage and salary rates on both sides of the Tasman would suggest that little has changed.
Therefore, are the currency markets right and every industry employer wrong? that is, NZ wages are about to lift 20% vis-à-vis Australia. I don’t think so, or in Tui billboard parlance – “yeah, right!”. Looks like the currency markets have this wrong.
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Roger J Kerr is a partner at PwC. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com
2 Comments
Roger,
Looks like the currency markets have this wrong.
I agree with you, although I tend to think the currency markets always have things wrong if reaching somewhere near a current account in balance was their fair value equilibrium position. While we have government and RB settings that are happy for NZ Inc to borrow and or sell as much as foreigners are happily willing to loan to us, or buy from us, then the currency will always be overvalued.
Your point presumably is that the NZD is especially so at present, largely no doubt due to expectations of rising interest rates compared to other countries.
You expect the NZD to come down, at least by a modest half cent or so; but think fair value against the Aussie is 5 cents off the current level.
The question will be whether Mr Wheeler does lift rates in March if the NZD has in fact not come off anywhere near the 5 cents against the Aussie. He may well then have a dilemma. If he does not lift rates due to the dollar, then it may drop to where he is more comfortable, but then he would want to raise rates, lifting it again.
I personally think he is better to err on the side of a competitive dollar, than worrying about whether inflation may tick over 3%, given inflation still looks very tame.
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