Roger J Kerr gives both the local and international reasons why the markets will be forced to rethink their view of the New Zealand currency

Roger J Kerr gives both the local and international reasons why the markets will be forced to rethink their view of the New Zealand currency

Marginally weaker than expected inflation figures on both sides of the Tasman for the March quarter have catapulted the AUD and NZD exchange rates out of their previous tight trading ranges against the USD to sharply lower levels.

The New Zealand CPI inflation increase released on 16 April was just +0.10% (consensus forecasts were +0.20%) and that pushed the Kiwi dollar down from 0.6750 to 0.6670.

The Australian inflation result on 24 April was also just below prior forecasts, however the 0.00% outcome was enough to cause a new wave of selling in the FX markets.

The NZD/USD rate closely followed the AUD/USD movements and plummeted to six months lows of 0.6580.

Currency and interest rate traders in both Australia and New Zealand have interpreted the lower inflation results as convincing both the RBNZ and RBA to cut official interest rates as early as next month.

The financial markets have reacted to the low inflation headlines and convinced themselves that the absence of price increases in the two economies means that economic growth is faltering, and further monetary policy stimulation is required with interest rate cuts.

The short-term reaction by the markets was perhaps understandable, however it does not seem sustainable when you look behind the headlines at the detail of what caused the low CPI inflation figures.

Global crude oil prices tumbled 40% (WTI reducing form US$75/barrel to US$45/barrel) in the October to December period last year after the expected lower supply out of Iran due to US sanctions never happened. That price decrease resulting in the 7% fall in petrol pump prices over the March quarter in the NZ CPI numbers. Air-fares also reduced due to seasonal and lower jet fuel price reasons.

However, since that time oil supply cuts by OPEC and other oil producers, as well as geo-political tensions in Libya and Venezuela, have reversed crude oil prices up by 44% to US$65/barrel.

The volatility and uncertainty of international oil price movements is why the RBNZ have it written into their monetary policy targets agreement that they must “look through” first round oil price changes on the headline inflation rate (i.e. ignore the temporary low inflation result for monetary policy management purposes).

On the assumption that oil prices stay higher through May and June, the markets will be looking at a much higher inflation outcome when the June quarter’s results are released in mid-July.

For this reason alone, the RBNZ will fail to deliver to FX and interest rate expectations of an OCR cut at the 8th May Monetary Policy Statement.

The other supporting reasons for a “no cut” decision is that non-tradable (domestic) inflation here in New Zealand is running at an annual rate of 2.8% and that global risks to the NZ economy have significantly reduced over recent months.

The greater risk and probability in respect to future NZD/USD exchange rate movements from the current spot rate of 0.6660 is a continuation of the reversal back up to 0.6700 and 0.6800 when the RBNZ deliver the message on 8th May that it is premature to be cutting the OCR interest rate.

The Reserve Bank of Australia will also be ignoring the oil price gyrations impacting their inflation and staying with their stated policy of not cutting their official interest rates unless they see their unemployment rate increasing. Recent employment and mining/commodity price data would suggest the opposite.

Four reasons why the Kiwi dollar sell-off will be short-lived

Looking ahead over coming weeks, two international developments and two NZ specific economic releases support the view that this latest Kiwi dollar sell-off will be short-lived.

The global factors that will be influencing RBNZ viewpoint and thus future NZ dollar direction are: -

  • The speech last week by Chinese Premier Xi Jinping to world leaders confirmed that China is making economic policy changes to meet the US on negotiating a trade agreement. A trade deal announcement is expected sometime during May and it will be unequivocally positive news for the NZD and AUD. The RBNZ will no longer be able to talk about trade war risks to the NZ economy in their 8th May statement.
  • US GDP growth of 3.2% (annualised) over the March quarter confounded the doomsayers who had been predicting a slide into US and world economic recession and thus lower currency values all round on cuts to interest rates. There were one-off factors that boosted the US growth over the quarter. However, as seen with company earnings results on Wall Street, the US economy remains robust in early 2019. Again, the RBNZ will need to drastically revise their previous view on global economic risks impacting on the NZ economy in 2019 and 2020.

The two local pieces of economic news due out this week that will cause the NZ economy and currency bears (or doves) to think again are: -

  • The monthly ANZ Business confidence/outlook survey is released on Tuesday 30th April. There is some debate as to whether the business firm respondents to the survey filled in their forms before or after the Government’s policy U-turn on the Capital Gains Tax on 17 April. A sharp rebound upwards in business confidence must be expected if the survey was conducted after the 17th – positive for the Kiwi dollar.
  • NZ employment data for the March quarter on Wednesday 1st May will also potentially be a Kiwi dollar positive if the rogue figures in the December quarter, which caused the unemployment rate to jump from 3.9% to 4.3%, are reversed. With most industry sector groups throughout New Zealand crying out about labour shortages, it is incomprehensible that the official figures are recording the unemployment rate rising!

RBNZ Governor, Adrian Orr was at pains to point out in his last statement that “it all depends upon upcoming economic data” when assessing the likelihood of an interest rate cut, or not.

He needs to ignore the March quarter’s inflation data for the reasons cited above and all the other NZ/global economic data has improved significantly over the last two months. The boom in our export figures in the month of March is just one example. FX market speculative positioning (short sold NZD’s) for an OCR rate cut on 8th May looks set to be reversed.

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*Roger J Kerr is Executive Chairman of Barrington Treasury Services NZ Limited. He has written commentaries on the NZ dollar since 1981. 

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3 Comments

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I enjoy reading this commentary and I think Roger makes some good points and you just have to see how the Kiwi bounced off .6580 last week, as buyers emerged etc.

On the other hand - the Aussie is currently sitting at just above .70 - and looks likely to slide further based upon their inflation figures last week - and per Roger's comments last week about the AUD - a week is a very long time in the currency markets:

Australian dollar breaking out of its downtrend?

The Aussie dollar exchange rate against the US dollar has been on a clear downtrend path since its jump up to 0.8100 in January 2018. Recent consolidation and stability between 0.7100 and 0.7200 are indicating a market sentiment shift back in favour of the AUD. Recent significant increases in metal and mining commodity prices point to the AUD/USD rate breaking out of its downtrend and moving higher to 0.7300 and 0.7400. Speculative FX market positioning is still extreme “short-sold AUD’s”. Watch for massive AUD buying demand when these positions are inevitably unwound (as the AUD fails to move lower). The NZD/USD rate will largely follow the AUD higher, not suggesting further Kiwi dollar depreciation below 0.6700.

AUD has been on a clear downtrend against USD since June 2011.The effect on inflation numbers ,as a result of the fall in fuel prices past quarter differed between New Zealand and Australia, so Australia is more likely to cut in May than New Zealand. If globally everything has turned rosy over the past two months , why have central banks in the same time frame done the opposite. Bottom line , neither New Zealand or Australia, can support a higher OCR, that is the unfortunate problem ,without collapsing the housing market,and in New Zealand's case its rural land prices.
The unemployment numbers this Thursday , given the adjustments Stats NZ are making could throw out any number between 3 and 6 or is that 4 n 20, they are not numbers that will dictate the path of the currency

I agree with you Cowpat. The idea that "everything has turned rosy" is difficult to rationalize based on central bank actions globally. As for NZD and AUD, whatever anyone says, these are still the "easy money" in terms of the carry trade (even if they weren't as easy as before). Exchange risk can be hedged relatively well by large institutions. The unemployment headline metric is garbage. Our understanding of employment needs to be focused on underemployment and a more qualitative understanding.