Roger J Kerr says the respective AU and NZ government budgets during May highlight the contrasts between the two economies, and currency markets are marking New Zealand as the clear winner

By Roger J Kerr

The New Zealand dollar has re-exerted itself over this last week, displaying its true colours in response to positive supporting factors such as high export commodity prices and a strong economy, as evidenced by last week’s NZ Government budget from Finance minister Steven Joyce.

Up until a week ago at exchange rates below 0.6900 the Kiwi dollar was underperforming against a weaker US dollar, due to lingering concerns over US trade protectionism, RBNZ forecasts of no OCR increase until 2019 and a struggling AUD on falling metal/mining commodity prices.

However, the direction and sentiment has changed back to the positive as the FX markets vote with their feet that the RBNZ will be forced by the economic data (i.e. inflation) to change their view and lift the OCR much earlier in 2018.

The NZD/USD rate has increased up through the previous technical/chart resistance point at 0.6950 and the flying Kiwi (currently 0.7060) is now threatening the next 200-day moving average chart point at 0.7100. The Kiwi has posted strong gains against all currencies with the TWI Index lifting from lows of 75.00 to 76.30.

The NZ budget on May 25th confirmed the strong financial position the National Government finds itself in with economic growth of over 3.00% for successive years delivering increased tax revenues and thus fiscal surpluses. The actual and projected surpluses allowed the Government to have the luxury of choices between spending increases, capital investment, tax cuts and debt reduction.

The balance was struck between fiscal prudence and financial incentives from income tax cuts to garner votes at the upcoming September general election.

Whilst the success of the economy, plentiful jobs and improved household financial health may seem a recipe for a relatively easy re-election of the National Government, the mood in the country is more focused on the environment, high immigration inflows and unaffordable house prices as election issues. Political risk for the Kiwi dollar was always going to increase from June onwards if the political opinion polls closed up on the ruling National Party.

A potential Labour/Greens coalition victory would be seen by most foreign investors into the NZ dollar as a negative due the uncertainty surrounding their more socialist economic policies and the divergence from the past policy prescriptions that have delivered a robust economy and a healthy financial position for the Government. How the public opinion polls move over coming weeks after the income tax cuts may well play a role in the direction of the NZ dollar.

Gains in the polls by the National Party would be seen as positive for the currency. The $2 billion fiscal stimulus for the economy in 2018 by way of income tax cuts will be inflationary and flies in the face of the latest RBNZ forecast of inflation falling back to 1.00% pa by March 2018 from the current 2.20% level. Required fiscal restraint by the Government over the last six years (to get us back from large budget deficits to surpluses) has been a partial handbrake on the economy. That restraint has now been relieved with fiscal policy initiatives of tax cuts and infrastructure investment adding to the strong economic growth performance.

As anticipated, the Kiwi dollar has outperformed the Australian dollar against the USD over recent weeks, resulting in the NZD/AUD cross-rate spectacularly rebounding from the 0.9200 area to 0.9480. Yet again, foreign investors and currency traders have recognised the differentiation between New Zealand and Australia in terms of New Zealand’s higher commodity prices, far superior Government finances and much higher probability that the RBNZ will be increasing interest rates considerably earlier in 2018 than the Reserve Bank of Australia. The respective Government’s budgets during the month of May were always going to highlight the contrasts between the two economies and currencies, New Zealand coming through as the clear winner.

Further gains for the NZD above 0.7100 against the USD over coming weeks will be much more difficult to achieve if the US dollar itself stages a comeback against the major currencies. The recent USD sell-off to $1.1200 against the Euro was due to the Trump administration’s impotency and delays on key pro-growth economic policies such as infrastructure investment and tax cuts. The budget put up by Trump lacks credibility with the numbers and so far the only “benefit” that Trump has delivered to the US economy is relaxed environmental regulations that has stimulated business investment. The next US Federal Reserve FOMC meeting on 13 and 14 June will lift short-term interest rates once again (80% priced-in already) and should push the EUR/USD exchange rates back to $1.1000.

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