By Roger J Kerr*
The NZD/USD exchange rate has traded within a narrow 0.6730 to 0.6850 range over this past week. The Kiwi has been unable to fully recover back upwards; however, it still appears that all the speculators who wanted to short-sell the NZ currency have now done so and therefore further selling has been exhausted.
The Australian dollar has fared somewhat better against a stable US dollar on global FX markets, rebounding to above 0.7400 as commodity markets stabilise.
Because of the superior performance of the AUD against the USD, as compared to NZD/USD movements, the NZD/AUD cross-rate has edged lower 0.9100.
Just three months ago in April the NZD/AUD cross-rate was trading closer to 0.9500.
The re-rating of the NZD downwards vis-à-vis the AUD is of no great surprise, as for the first time in several years the outlook for the Australian economy looks better than New Zealand. In addition, our export commodity prices have started to pull back from record highs, whereas Australia’s metal and mining commodity prices have been bouncing along the bottom of their respective trading ranges and have greater propensity to increase than what ours do.
Foreign exchange markets always price-in today the likely future or forecast economic and market conditions, they rarely reflect the actual situation today.
The NZD/AUD cross-rate is not expected to move any lower than 0.9100 on this downtrend, as all the speculators in the NZD/USD market are over-extended on short-sold NZD positions already and are likely to be aggressive NZD buyers over coming weeks as the unwind those positions (refer last week’s commentary piece).
Therefore, local AUD exporters should be pushing hedging percentages upwards to near maximums of policy bands at 0.9100. Tuesday’s NZ inflation result for the June quarter stands likely to push the Kiwi dollar higher on its own accord if the increase is above 0.50%.
Over recent months it appears that global financial and investment markets have become largely immune to the unpredictable, inconsistent and wild statements from US President, Donald Trump on trade and other economic policies.
US equity markets have stopped reacting to the barrage of tweets, as have bond and currency markets.
The USD exchange rate to the Euro has remained in a tight band between $1.15 and $1.20 for several months now and seems unlikely to break higher or lower over coming months as the northern hemisphere markets move into summer holiday wind-down mode.
The escalating trade war between the US and its trading partners in China, the America’s and Europe has not dented the USD’s value to date.
However, the markets appear reluctant to buy the USD as well, as in the end, the protectionist tariffs being forced on to the US economy by Trump will be negative for US growth and jobs.
The US dollar weakened from $1.05 (against the Euro) when Trump came to power in late 2016 to $1.25 earlier this year due to US political risks and premature expectations that the Europeans would increase their interest rates. The recovery in the USD to its current $1.17 level has reflected increasing US interest rates from the Federal Reserve this year.
President Trump’s first two economic policy changes, namely corporate tax cuts and reductions in environmental regulations on business, proved to be very positive for the US economy.
These have been his triumphs so far, albeit the tax cuts certainly blow out the internal budget deficit next year and subsequent years.
However, his third economic policy initiative on trade protectionism is already causing adverse changes to US business investment as domestic manufacturing becomes uncompetitive (e.g. Harley Davidson and Tesla switching manufacturing to outside of the US).
The Trump administration seem to want to force the Chinese to make concessions and somehow miraculously right the trade imbalance between the two economies.
Globalisation of manufacturing of component parts and integrated supply chains are just too advanced today to sever the US off as an isolated and fully functioning part.
A continuation down the isolationist trade path that the US are now travelling will prove to be the tragedy for the US economy and the legacy of the Trump regime.
Being the real estate tycoon, he once was, Trump sees everything as a simple “deal” to be won against the opponent.
He promotes extreme opening positions in expectation of giving ground later to get what he wants.
Unfortunately, global manufacturing and import/export trade are much more complicated than buying hotels.
The financial and investment markets have concluded that Trumps rants are best ignored, however what they cannot ignore is the likely economic consequences of his protectionist trade policies.
Lower US economic growth with higher inflation (i.e. imported products increasing in price) equates to stagflation.
Couple that US economic scenario/direction with massive budget deficits and the conclusion is a very negative one for the US dollar’s value going forward.
Within the next few months the FX markets will have fully priced-in two more Federal Reserve interest rate hikes this year and up to three hikes next year.
After that, the positives for the USD will have run out. For these reasons it is difficult to see the NZD/USD exchange rate going lower due to a stronger USD. A more likely outcome in late 2018 and into 2019 is a weaker USD on global FX markets, propelling the NZD/USD rate well above 0.7000.
*Roger J Kerr is an independent treasury Management advisor. He has written commentaries on the NZ Dollar since 1981.