By Roger J Kerr
The events and results that unfold this week from the US Presidential Election and RBNZ Monetary Policy Statement are set to determine the level and direction over the NZD/USD exchange rate over the next few months.
Over the last week in the lead up to the 8th November vote in America the US dollar exchange rate has weakened as the Republican candidate Donald Trump has made some gains in the political opinion polls.
The election outcome appears to be on a knife-edge and financial markets do not like the resultant sheer uncertainty. The reaction by the FX markets to the Trump poll gains has been to sell the USD against the Euro from below $1.0900 to above $1.1100, as they factor in no interest rate increases in mid-December by the Federal Reserve.
As a result of the general US dollar weakness, the Kiwi dollar has jumped up to above 0.7300 from the low 0.7100 area a week ago.
The likely movement scenarios for the NZD/USD exchange rate from this coming week’s events and results are seen by this commentator as follows:-
Scenario 1: Clinton victory and RBNZ aggressive about further OCR cuts (40% probability)
The FX markets will see a Clinton win as “business as usual” for the Fed and the US economy. Therefore, a Fed Funds interest rate hike in December which propels the USD back to below $1.0900 against the Euro. A cut by the RBNZ and a clear message from them that the high exchange rate will mean further cuts are necessary below 1.75% to get inflation higher, should send the NZD/USD rate below 0.7100 immediately and then heading below 0.7000 over coming weeks.
Scenario 2: Clinton victory and RBNZ disappoint the markets about further OCR cuts (30% probability)
The stronger USD will prevent further NZD gains above 0.7300. Under this scenario the local FX markets will conclude that the RBNZ have finished with OCR cuts and the next move (perhaps later in 2017?) will be up for NZ interest rates. The NZD/USD exchange rate will therefore struggle to trade below 0.7100 unless the USD itself really takes off to $1.0500 to the Euro.
Scenario 3: Trump victory and RBNZ are aggressive about further OCR cuts (20% probability)
On a surprise Trump victory the US dollar would initially weaken further to $1.1300 against the Euro. To guard against the weaker US dollar the Trump win would produce, RBNZ Governor Wheeler gets aggressive with his words about the need for additional OCR cuts well below 1.75% to force the Kiwi dollar down. A Trump victory would be very negative for US sharemarkets and the “risk-off” investor sentiment that would come with that would see the NZ dollar sold across the FX markets. A lower NZD/USD rate to 0.7100, coupled with a weaker USD against the Euro would see the NZD cross-rates to the Euro, Pound, Yen and AUD all move sharply lower.
Scenario 4: Trump victory and RBNZ disappoint about further OCR cuts (10% probability)
It would be a very low probability that a Trump win that sends the US dollar lower would be followed by a RBNZ statement that disappoints the FX markets and automatically sends the Kiwi dollar higher on its own accord. Under this scenario the NZD/USD moves up to 0.7500 and all the cross-rates also move dramatically higher. The end result would be a TWI Index above 80.0 and the RBNZ struggling to explain its actions.
The NZ dollar has been buoyed higher by another stellar increase in wholemilk powder prices, a marginal increase in inflationary expectations in the RBNZ survey and yet another strong employment number in the September quarter. The NZ economy continues to hum along with the only previous negative of low dairy prices now rapidly disappearing.
The Australian dollar has made gains over recent weeks against the USD as the forex markets conclude that the RBA are done with further interest rate reductions. However, the AUD/USD exchange rate has encountered stiff resistance from trading above 0.7700 over the last 12 months and this cap should once again hold firm. The RBNZ will be recognising the plight of local exporters selling in AUD’s above 0.9500 yet again. If the RBA are indeed “done” with further rate cuts, it is doubly important that the RBNZ signal the need for further rate cuts in NZ to differentiate the Kiwi against the Aussie dollar and drive the NZD/AUD exchange rate lower.
Local importers and exporters not already currency hedged against the various scenario permutations and “event risk” of the US election may need to hastily consider some short-term FX option protection.
Roger J Kerr contracts to PwC in the treasury advisory area. 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