By Gareth Vaughan
A tumultuous start to 2016 for equity, commodity and currency markets could suggest risk aversion from international investors and traders towards the New Zealand dollar might see it fall. However with our interest rates high by global standards, the Kiwi is more than holding its own and probably higher than New Zealand's economic fundamentals justify, says HiFX director of sales Dan Bell.
In interest.co.nz's monthly currencies report, Bell notes the Official Cash Rate (OCR), even at its historic low of 2.5%, gives New Zealand interest rates among the highest in the developed world. Australia, one of our key trading partners, has a Cash Rate of 2%, in comparison. And in the US the Federal Funds Rate is 0.25% to 0.50% following a rate hike just before Christmas. Elsewhere the Bank of England and Bank of Canada are both at 0.5%, the European Central Bank's at 0.05% and the Bank of Japan's at 0%.
"if you line everything up in the New Zealand economy you'd have to argue that things are a bit average," says Bell.
"Obviously commodity prices have been hammered, dairy prices are already down again another 10% this year. And you look at our major trading partners, things have started the year pretty sluggish. And with that ongoing uncertainty in China, global equity markets are down 15% to 20% from their peaks last year. So in this kind of environment you'd imagine the Reserve Bank has got room to cut, but the recent rhetoric from the RBNZ is they're not in any hurry," says Bell.
"Obviously they've got an underlying easing bias but he (Reserve Bank Governor Graeme Wheeler) is looking through the lower inflation outcome that the economy's generating and saying 'well, actually it's pretty much oil and energy related' and I think his thinking is that there's not a hell of a lot that a lower cash rate is going to do to inflation," Bell adds.
"The message this year is we're going to be in a very volatile year on all fronts, whether it's across the equity markets, commodities and currencies. So that tends to create a more negative environment for the New Zealand dollar. But at the same time if the RBNZ decide to keep interest rates where they're at, that should provide a bit of support (for the NZ$)."
Fed hike this year 'barely priced in'
Meanwhile, the US Federal Reserve, having hiked rates for the first time in almost a decade late in 2015, was expected by financial markets to raise rates up to another four times this year. However, this expectation has now gone out the window.
"Market pricing at the moment is barely pricing in a rate hike this year and certainly no rate hike over the next three to six months. So suddenly you've got the US Federal Reserve being questioned by the market around their interest rate policy and that volatility, I think, is a reflection of that uncertainty. The market is saying 'is now the time to be tightening monetary policy in the world's largest economy when we've got a lot of issues around the world'. So the Fed again are going to be in a really difficult position," Bell suggests.
Testimony from Fed chairman Janet Yellen to the US Congress this week will be closely watched for signals of her intentions.
"We're probably going to get some insights into her thinking. But they (the Fed) are going to be in another very, very difficult position this year to try and raise interest rates when the market is saying 'now is not the time.'"
RBA & Fed calls important for NZ dollar
Bell notes the NZ dollar has been trading in a range of about US4 cents from US64c to US68c. Decisions from overseas central banks could be key influences in how it moves in the months ahead.
"We've got potential that the Fed push out further rate hikes, which will be ultimately negative for the US dollar and that could provide support to the New Zealand dollar, which ultimately the Reserve Bank doesn't want to see. They don't want to see the New Zealand dollar stronger against our major trading partners with weaker commodity prices and the current backdrop in the economy."
"I think particularly if we saw the Reserve Bank of Australia cut interest rates again, if we saw the Federal Reserve push out the tightening this year, the RBNZ is going to end up having its back against the wall and currency is going to have to factor into their decision making this year, particularly if it goes up," Bell adds.
"So I'd be watching the global central banks as much as what's happening locally in terms of what the RBNZ ultimately do."
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.