By Roger J Kerr
There has been more to the New Zealand dollar sell-off over the last two weeks than just renewed US dollar strength and/or Aussie dollar weakness. From highs of 0.7390 on 13 April, the Kiwi has been slammed down relentlessly by the global FX markets to a low of 0.7040 last Friday 27 April.
Two additional factors contributed to the sudden turn in the tide for the Kiwi dollar:-
- Currency market positioning: As previously highlighted in this column, the movement upwards in the NZD/USD exchange rate from 0.7180 in late March to 0.7390 was solely due to speculative buying. When the direction changed and further Kiwi gains were not being achieved above 0.7400, those speculative long NZD position holders were always going to unwind and become big NZD sellers. The low inflation headlines helped the negative sentiment. The rapid fall below the previous support line at 0.7180 triggered further stop-loss NZD sell orders and exaggerated the plunge down to 0.7040.
- NZ Government policy changes: It will be always hard to ascertain just how much the Government’s sudden policy change on banning new offshore oil and gas exploration impacted on foreign investor perceptions of New Zealand; however, it was not a positive signal. The decision would certainly make foreign investors think twice about the new risks of putting money into New Zealand. Foreign exchange markets pick up the nuances, sentiment around business-related capital flows very quickly, and the Government policy change added to the negative environment for the Kiwi dollar.
The US dollar itself has finally started to recover against the Euro after weakening significantly on US political risk and stronger Euroland economic data through late 2017 and early 2018. The EUR/USD exchange rate after moving rapidly from $1.1500 to $1.2500 (USD weakening) over that period was never pushed above the $1.2500 barrier and has recovered of late to $1.2100.
The stronger US dollar on world FX markets of late has been due to US short-term interest rates arguably being increased in 2018 at a faster clip than earlier expected and European economic data softening through the first few months of 2018. The renewed USD strength is certainly justified on higher interest rate yields and continuing strong US economic data.
However, larger US internal budget deficits (due to the Trump tax cuts and spending increases) in 2019 and 2020 remain negative for the US dollar in the medium to longer term.
A stronger US dollar over coming months to just below $1.2000 against the Euro may well pull the NZD/USD rate into the 0.6800/0.6900 region again, however further sustainable USD strength appears unlikely against the negative US budget deficit backdrop.
The recent NZ dollar weakness to below 0.7100 is very good news for primary sector exporters as international commodity prices have not changed and remain near their historical highs. The news is not so good for motorists and the transport/freight sector with higher oil prices and the lower Kiwi dollar exchange rate about to push fuel prices sharply higher.
Herein lies a fresh challenge for the new RBNZ Governor Adrian Orr who may need to balance off a slower GDP growth rate for the NZ economy this year and next with inflation rising.
Under their monetary policy framework, the RBNZ “look through” first-round oil price increases on the inflation rate (i.e. do not adjust monetary policy, as they cannot control global oil prices). However, should second-round general prices in the economy increase because of higher freight/transport costs being recouped, a tighter monetary policy response would be required. Very few would see “stagflation” (higher inflation with no growth) as a potential scenario for the NZ economy going forward, but it should not be totally ruled out.
It does look like that the lower NZ business confidence levels will recover too much this year and now consumer confidence is waning as well. The previous positive NZ economic growth story has a few chinks and the outlook is not as positive.
The local currency market will again be looking to this week’s GDT auction to see if the recent stable dairy prices can be sustained. Beyond that, the RBNZ Monetary Policy Statement on 10 May and the ultimatum 12 May date for the US review of Iran sanctions loom as key FX market events.
The Australian dollar has depreciated nearly six cents from its highs of 0.8135 against the USD in late January. The NZD has depreciated by just over three cents from 0.7400 over the same period. The difference is due to NZ export commodity prices remaining stable (dairy), whereas Australian export commodity prices (iron ore) have fallen sharply. Should the commodity price differential reverse from here, we would have to expect to lower NZD/AUD cross-rate to 0.9200 from the current 0.9350 rate.
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.