By Gareth Vaughan
The New Zealand dollar appears set for another volatile year in 2016, says Dan Bell, director of sales at HiFX.
But firstly in our monthly never a dull moment currencies report, after a year of "will they or won't they", the US Federal Reserve increased the Federal Funds Rate, the US equivalent of the Official Cash Rate, for the first time since June 2006. The Fed Funds rate was hiked to 0.25% to 0.50% from zero to 0.25% on December 17.
"It was good to see that they've finally made a decision on that front. They've been telegraphing it for a long, long time. At the start of the year they were pretty certain that they were going to raise interest rates this year. They got a little bit unsettled during that period of Chinese stock market volatility back in September when global equity markets were down 10% or so. They've seen that things have stabilised, their economy is still moving in the right direction, it's not gangbusters, but it's moving in the right direction, the labour market has significantly improved, and it's time to start raising interest rates," Bell says.
Despite the Fed rate hike, and Reserve Bank of New Zealand's fourth OCR cut of the year a week earlier dropping the OCR to 2.5%, the Kiwi dollar has strengthened. As Bell notes, "The Kiwi is frustratingly strong at the moment and certainly not where the Reserve Bank of New Zealand wants it to be."
"What has happened is the market has taken the commentary from the RBNZ to suggest that we're not going to see any interest rate cuts next year and inflation is going to tick up going forward. (So) suddenly we're looking at maybe we've found a bottom for the cash rate in New Zealand again."
At the time the video with Bell was recorded the NZ dollar was trading around US67.5 cents, having been as low as US62.5c in September and almost up to US69c since. The Fed's plans to increase the Fed Funds Rate further next year will continue to support the greenback meaning it will outperform, Bell says.
"The European Central Bank are still committed to quantitative easing and much more stimulatory settings, for their economy. I mean negative interest rates and printing money you can't get much more stimulatory than that. Likewise Japan, they've got the same posture at the moment around their interest rates with quantitative easing and low interest rates. So I think the US dollar will strengthen into next year against the New Zealand dollar and the Aussie dollar."
"I don't think our central banks (RBNZ and Reserve Bank of Australia) are going to be in too much of a hurry to do much next year," adds Bell.
"Some of the commentary coming out of the Fed, out of the RBA out of the RBNZ even is that the current (low) inflation environment is being impacted by the calculation of the impact of the lower oil prices into the annual calculation of the CPI (consumers price index). So what they're suggesting is when we get into next year and that calculation gets reset, that inflation will actually start to push up as it's calculated on an annualised basis."
"Whether or not we're going to see inflation take off next year I'm not personally convinced. We've been talking about the inflation genie for a long time now and it still hasn't come out of the bottle. Does the global growth outlook support a significant risk of high inflation next year? I don't believe so. Certainly growth is still pretty tepid globally and it seems as if most central banks are still pretty concerned about the outlook for their economies," Bell says.
For the September year inflation came in at just 0.,4%. However, the Reserve Bank this month predicted inflation would "move inside" its 1% to 3% target range from early 2016 as earlier petrol price declines drop out of the annual calculation, and the lower New Zealand dollar will be reflected in higher tradables prices.
"So yes we'll see the Fed raising interest rates and I think that will continue to support the US dollar, But I don't see a huge response from the RBNZ. I think it's going to give the RBNZ a little more room to manoeuvre, if in fact we did see an uptick in inflation, that the Fed are raising interest rates," says Bell.
"But obviously they (the RBNZ) need to take into account the impact that has on the (NZ) dollar and at this point in time they didn't expect the NZ dollar to be as strong as it is. And If they (RBNZ) maintain a more hawkish outlook around inflation, I think we'll see this Kiwi dollar continue to push up," Bell says noting it was above AU94c recently and "could easily be back over US70c against the US dollar."
"And when our terms of trade has been hammered like it has this year, with particularly milk prices down a good 50%, that's not where the Reserve Bank wants to see our currency. So currency will continue to be a big issue for them (the RBNZ) next year that's for sure.
Businesses exposed to currency fluctuations need a plan
With the Fed tone suggesting one rate hike every quarter during 2016 assuming US economic data can justify such moves, Bell suggests there could be a rollercoaster for the Kiwi dollar ahead.
"We are going to see another volatile year. I think in a year where the Fed are going to be raising interest rates the market will be watching the data flow out of the US very, very closely. At the same time you've still got certain risks in China, you've got ongoing issues in certain economies in the European region, you've got geo-political tensions that seem to be getting worse through the Middle East and other parts of the world, so there's plenty to keep the market guessing next year and that will flow through to volatility," says Bell.
"This year the Kiwi dollar has had a range of about 25% against the US dollar, it averages around 20% (a year). People forget how volatile our currency is even in the best of years. Next year again will be another volatile year and with uncertainty from the biggest central bank in the world, you can guarantee that will be a big driver."
"I think the main thing for businesses that are exposed to currency is to have a plan. The key message is not to try and guess or forecast what's going to happen, it's to have a plan. Start the year with a plan and follow through with a strategy and a plan that makes sense to your business. (Because) for sure volatility will be here next year in spades," Bell says.
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.