Roger J Kerr says the foreign exchange markets have been slow to recognise the downside to the NZ economy from the escalating US/China trade war

By Roger J Kerr

Contrary to the expectations of this column over recent weeks, the Kiwi dollar has managed to stay above its key support level at 0.7180 and thus has remained in its established range against the USD.

For the fourth or fifth time over recent weeks, the NZD/USD rate has bounced up again from depreciation to just below 0.7200.

However, the gains back up again are becoming increasingly weaker, with this week’s recovery running out of steam at 0.7320.

The surge back upwards in the Kiwi was a little surprising given that the Aussie dollar was going the other way against the USD as the tit-for-tat US/China trade war gained momentum.

The Kiwi gains back up to 0.7300 did not appear to be supported at all by a stronger AUD or weaker USD on global FX markets, therefore the NZD buying appears to be short-term, speculative in nature (thus likely to be short-lived and easily reversible).

Some economic analysts see the escalating US/China trade war as potentially positive for New Zealand in the short-term because we have less competition from the US in export markets like wine into China.

In the longer-term, however, greater trade protectionism by our trading partners is a major negative for the NZ export sector.

Our economy has benefited from greater market access under the numerous international free trade agreements over the last 25 years. A reversing to less access is certainly damaging to our economy.

The FX markets are yet to recognise this risk and to date have not marked the NZ dollar down.

Whilst the verdict from US equity markets towards the increasing trade tensions has been very negative, many investors are perhaps waiting to see how much of the bluster from president Trump turns into economic reality.

Certainly, New Zealand beef farmers and exporters will not be happy to see beef commodity prices sliding in the US domestic market as Chinese tariffs on US pork exports forces a greater supply of pork onto their home market and thus lower prices. Beef prices, needing to maintain price relativity, have followed the pork prices lower.

There are never any winners with trade wars and Trump may have seriously underestimated the financial clout of the Chinese if they decide to restrict US investment/businesses into China and stop financing the US Government’s debt requirements (i.e. the Chinese become sellers of US Treasury Bonds, not buyers).

However, in the meantime Trump knows that the negative financial impact on China from US trade protectionism on US$600 billion of Chinese exports to the US is far greater than the US$150 billion of US goods going into China each year.

The losers from the trade war will be US consumers paying higher prices for all sorts of products and US agricultural producers (pork, beef, soya beans etc) suffering lower market prices.

Trump is after the political support from blue-collar industrial workers in the mid-west seeing more jobs; however, the business economics of global manufacturing supply chains does not suggest any great expansion in US factories and jobs because of the protectionist tariffs.

The Kiwi dollar has continued to outperform the AUD against the USD, resulting in the NZD/AUD cross-rate shooting up to 0.9460. The steep gains of the Kiwi against the Aussie appear to also be speculative in nature and thus prone to equally rapid reversal when the long-NZD positions are unwound.

The NZD/USD exchange rate can be expected to follow global equity markets lower over coming weeks as economists’ lower GDP growth forecasts (thus lower commodity prices) and uncertainties increase as to what the unpredictable Trump administration will do next.

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.