By Gareth Vaughan
If not quite a lay down misere, the US Federal Reserve is expected to finally raise interest rates next month meaning downward pressure on the New Zealand dollar, says Dan Bell, director of sales at HiFX.
In our monthly never a dull moment currencies report Bell says after a very strong US jobs report last Friday night, financial markets expect the Fed to increase the Federal Funds Rate at the next Federal Open Markets Committee meeting on December 16 and 17 (NZ time). It has been an ongoing question and debate this year as to whether the Fed will increase interest rates for the first time since June 2006.
"The US have had interest rates down at 0-0.25% for a very long time now. They've undertaken this quantitative easing programme over the last few years. We're at a point where I think the Fed needs to raise interest rates to give them a bit of room to manoeuvre if in fact we do see a slowdown in their economy next year or the year after. And at the end of the day you don't have any room to manoeuvre when your rates are at zero. That's it, you need to go out there and start printing money again," says Bell.
"So I think the door is open now and the Fed need to respond accordingly."
The October US jobs, or non-farm payrolls, report saw 271,000 jobs added, smashing economists' expectations for 185,000. The jobless rate fell to a seven-year low of 5% and average hourly earnings over the past 12 months rose the most since 2009. In a previous decision to put off a rate hike, the Fed cited global uncertainty centered around turmoil on China's sharemarkets. However, this has since calmed removing another reason for the Fed not to increase rates.
In October last year the Fed brought the curtain down on its quantitative easing, bond buying, or money printing programme that was put in place at the height of the Global Financial Crisis in 2008. All up, this saw the Fed add US$3.7 trillion worth of assets to its balance sheet, which was about an eight-fold increase. However, the Federal Funds Rate, the US equivalent of New Zealand's Official Cash Rate (OCR), remains at 0 to 0.25%, where it has been since December 2008. The Fed Funds Rate was last increased in June 2006, by 25 basis points to 5.25%.
What about the RBNZ?
On December 10, a week prior to the Fed announcement, the Reserve Bank of New Zealand issues its final OCR review and Monetary Policy Statement for the year. Bell suggests it's a 50/50 call as to whether the OCR is cut from its current 2.75%. The OCR was cut three consecutive times from June to September by a combined 75 basis points, but left unchanged at the last OCR review on October 29.
"A couple of weeks ago the market was definitely leaning towards another rate cut from the RBNZ. The most recent comments from the Governor (Graeme Wheeler) haven't really been that conclusive around that outcome. The most recent price action would suggest that we're not going to see a meaningful recovery in dairy prices over the next few months. We've got a growing risk of drought and El Nino in this country, certain measures of confidence in the economy aren't really that great," says Bell.
"There's bits and pieces of negatively coming into the NZ economy which I think the Governor's going to be concerned about. So I still think December's about a 50/50 call in terms of the RBNZ. (With the) cash rate at 2.75% I think there's still an easing bias. So we'll see what he does then. If he doesn't cut interest rates I think we'll see a decent uplift in the New Zealand dollar, which isn't what he wants," Bell says.
That, however, may be a short-term scenario if the Fed hikes a week later.
"At current levels we think the New Zealand dollar is in the middle of the range," Bell says.
"For us we still think there's more downside risk as we move into the Fed tightening cycle and as commodity prices remain under pressure. So going into next year we still think the New Zealand dollar has got more downside. It doesn't look like it's going to collapse now because things have calmed down globally. But we do think it has got more weakness ahead."
"So anything for an importer over US65c to US66c is looking reasonably good at the moment, and exporters obviously in terms of where we are relatively to where we were last year, current levels are still pretty good," Bell says.
"So I think we've got a downside bias with a sell on the rallies for importers."
In terms of the Kiwi-Aussie dollar cross rate, he sees a trading range currently of between AU91c and AU96c. And elsewhere Bell suggests there's a "decent chance" of the Bank of England increasing interest rates next year, which will support the pound.
"I think once the Fed raises it's going to open the door for the Bank of England as long as their economy continues along its current path. So I think we'll continue to see more strength in the pound versus the New Zealand dollar."
Where's the inflation?
That said, Bell expects the lack of inflation to be an ongoing global story and a big driver of financial markets and currencies.
"In every major economy you're not seeing any meaningful inflation. So you've got all these central banks around the world with these very, very low interest rates. You've got forms of quantitative easing which are going on in Japan and Europe. You've got the US, which okay we're going to see an interest rate hike from the US, but it's only going to take their rate to 0.25% (to 0.50%), so there's still not a lot the world can do around this deflation issue."
"And I think that's going to continue to be a big story and a big driver of financial markets going forward and of the currency. We've seen a little bit of a stabilisation in the New Zealand dollar consolidating around US65.50c over the last few days probably reflecting the fact that hey, whilst interest rates are low in New Zealand on a historical basis, our cash rate at 2.75% is still one of the highest in the world," says Bell.
Dan Bell is director of sales at HiFX, a UK-headquartered foreign exchange dealer with significant operations in Australia and New Zealand. It has a dealing room in Auckland. See more detail here.