By Roger J Kerr
The attention of global currency markets will be heavily focused on geo-political developments over the next period, particularly the international trade relationship between the US and China, as President Trump meets Chinese leader Xi Jinping for the first time this week.
Following the epic Trump political failure in the US Congress to repeal the Obamacare health regime, the US President is rapidly turning his attention to protectionist trade policies as he accuses the Chinese of causing the US’s growing trade deficit.
The Americans blame the Chinese of being one of most protectionist of the major countries, whereas the US is about the least protectionist in their view.
The strong rhetoric from the US ahead of the Trump/Xi meeting does put the two largest economies on a path to a retaliatory trade war, which would not be in anyone’s interests.
Just how far the Trump administration will go with import tariffs or border taxes on imported goods remains to be seen.
At this stage they just seem intent on tightening the current trade rules with anti-dumping penalties and countervailing duties. The Americans want their international trade arrangements to be “fair” i.e. slanted to the US’s interests and disregarding what it means for the other guy!
President Trump wants a complete country-by-country and product-by-product assessment of the causes of US trade deficits within the next three months.
The exercise will cover faulty trade deals, cheating by foreign competitors, currency misalignments and constraints imposed by the WTO.
It is unlikely that President Trump will accuse President Xi at their meeting of manipulating the Chinese Yuan currency value to aid Chinese exports into the US. Currency manipulation by the Chinese was one of the Trump pre-election pledges that he would address.
However, many other domestic and international factors determine China’s exchange rate policy and the Yuan’s value. Currently the Chinese are not wanting the Yuan to depreciate against a stronger US dollar as that trend encourages capital flight out of China.
The Chinese have been reducing their holdings of US Treasury Bonds over recent times and repatriating funds home to ensure the Yuan remains stable.
Surely, someone will remind President Trump that the Chinese Government and their sovereign wealth funds are the US’s largest creditor through their funding of the US government debt (investors in US Treasury Bonds). Upset them too much and the US may find that the Chinese sell a lot more Treasury Bonds, sending US long-term interest rates higher and stalling US economic growth.
The Chinese can hardly be accused of weakening their currency when their latest economic data is stronger and they are now quietly tightening their monetary policy settings.
There still remains a reasonable probability that the Trump administration will back-track on the promised 40% tariff on Chinese imports.
The economic and business reality is that 50% of the US’s imports from China are intermediate component parts for US manufacturing factories. Increase that cost and the unintended negative consequence will be that US manufacturers are less competitive, resulting in job reductions and lower US economic growth.
The complete opposite to what Trump said he would deliver. “Fortress America” policies would be detrimental to the US economy, not positive as some of Trump’s ill-informed trade advisors believe.
The US dollar did weaken back to $1.0800 against the Euro following the Fed interest rate hike in mid-March. Some market participants were expecting the Fed to increase their forward guidance on the number of interest rate increases in 2017, and when the Fed stuck to their original script of three 0.25% increases in 2017 there was some unwinding of long USD positions. However, continuing stronger US economic data has returned the USD/EUR rate to $1.0650. A generally stable US dollar against the Euro in the $1.0400 to $1.0800 trading range over coming months will mean that there is no major impact on the NZD/USD exchange rate from global currency shifts.
Following the correction back down in whole milk powder dairy prices from US$3,500/MT to US$2,700/MT over recent weeks, the outlook from here for dairy prices is also one of stability in New Zealand’s largest export commodity.
The RBNZ are on a semi-permanent “neutral-hold” with monetary policy settings this year, therefore there will be no influence on the Kiwi dollar from that source either. In terms of the remaining NZ dollar drivers of future value or movement, the reaction of the Australian dollar to a possible correction downwards in metal and mining commodity prices stands as the only potential negative.
The AUD/USD exchange rate has again retreated from its barrier/ceiling at 0.7700 and falling iron ore and copper prices would send the rate lower than the current 0.7630 level.
The Australian mining commodity prices were pushed up following Trump’s election victory last November on the expectation of the massive US infrastructure investment plans. There is still no US policy detail in this area and with Chinese wharf stockpiles building up, the Aussie dollar has to be vulnerable to a commodity price correction. The NZD/USD rate would not depreciate as far at the AUD/USD rate, therefore a higher NZD/AUD cross-rate above 0.9200 is on the cards.
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