Having depreciated three cents against the US dollar from 0.6900 to 0.6600 over the last 10 weeks on the back of lower inflation and RBNZ actions, the Kiwi dollar now appears marooned at the 0.6600 level and is in search of new direction.
The Australian dollar has depreciated two cents to 0.7000 against the USD over the same period, however the RBA has held off for the meantime in cutting their interest rates.
The US dollar itself has been very stable on the world stage since late March also, with no great currency market reaction to lower interest rates in the US or the latest ramp-up in trade tensions between the US and China.
There is nothing to suggest from these recent events, or from wider economic developments, that would justify the Kiwi dollar moving out of the broad 0.6500 to 0.7000 trading range, which has held firm for the last 12 months.
Contrary to the expectations of this column, the Kiwi has however decisively broken below the earlier inner trading band of 0.6750 to 0.6850.
For the NZ dollar to depreciate further to sustainably below 0.6500, either the US dollar would need to appreciate substantially against all currencies and/or our export commodity prices collapse. Neither factors seem likely over the next 12 months.
Over the last 40 years the US dollar has always weakened in value when their internal Government budget deficit increases is size to above 5% of GDP.
The Trump tax cuts and spending increases are forecast to increases their budget deficit from the current 4% to well above 6% over the next 24 months. The US does not have enough domestic savings each year to fund all their annual deficit shortfall. Therefore, the only way foreign capital flows can be attracted into the US to fund the balance is though the currency firstly depreciating to an acceptable entry point for the foreign investors to come in.
Interest rate cut unlikely to prompt higher inflation
The fact that the Kiwi dollar has not budged from the 0.6600 level following the RBNZ decision to cut the OCR interest rate to 1.50% on the 9th of May, indicates that the FX markets were short-sold Kiwi dollars going into the monetary policy announcement.
There has been no follow-through selling as the RBNZ did not paint a bleak enough economic picture to suggest further interest rate reductions will be needed.
On the other side, there has been no fresh positive news to cause the Kiwi dollar to recover back upwards.
The local interest rate market was 50/50 on whether the RBNZ would cut, so it was a surprise decision for many.
The RBNZ’s rationale for loosening monetary policy at this time seems to hinge on economic growth and inflation being marginally weaker than they expected over the last six months.
However, adjusting the monetary levers today should be about the future and forecast economic conditions in nine to 12 months’ time as it takes that long to make an impact.
It seems the activist Governor Adrian Orr was keen to follow-through on his signal a month ago that the balance had shifted in favour of lower interest rates.
It is not clear why the economy needs additional stimulus other than annual inflation has been tracking below the 2% target for some time.
If the RBNZ’s reasoning is that lower mortgage interest rates will stimulate more consumer spending and that demand will push up prices in the economy, they will be disappointed.
History has told us that higher inflation in the NZ economy always comes from the supply side, not the demand side.
Over recent years it has been the supply of consumer goods that have consistently reduced in price due to ever advancing technology that has caused the low inflation outcome.
The technology gains and resultant price decreases have swamped and disguised other price increases that households have been forced to pay.
What was also very surprising in the RBNZ’s statement was that there was scant mention of the large fall in fuel prices in the March quarter that caused the low inflation result. Oil prices have since reversed back up. The RBNZ are required to “look through” these price changes that they cannot control and not adjust monetary policy due to such changes.
The strong argument for not reducing interest rates is that you do not want to waste your bullets today when you may need all of them at some future date if the economy really turns to custard.
The RBNZ have decided to fire off some bullets now in a precautionary move, however their impact on inflation outcomes seems negligible (for the reasons stated above) and it is at the expense of losing future monetary policy flexibility. The risk/reward equation in this respect does not seem to stack up in the writer’s opinion.
US/China trade deal remains as largest Kiwi dollar positive
Looking ahead, the local FX market now no longer has a threat of lower interest rates as a negative variable for the Kiwi dollar.
The variables that will determine its future direction now centre on the US/China trade agreement outcome, a return to higher business confidence levels (post the capital gains tax U-turn), higher Australasian commodity prices and the whether the US dollar itself weakens on their budget deficit situation.
All the aforementioned factors are positive for the Kiwi. However, it will require a catalyst to stimulate speculative buying of the NZ currency. That catalyst could well come in the shape of a China/US trade deal, even if recent events suggest that the parties are not as close on several points as the markets thought they were.
There are certainly mixed and unpredictable messages coming from President Trump, but both the US and China know that the global economy needs them to compromise and reach an agreement.
It is in no-one’s interests that the trade negotiations break down into a full out trade war. The Kiwi dollar would depreciate well below 0.6500 if this did happen. However, the greater probability is that the US and China do reach agreement within the next month and both the AUD and NZD appreciate as a result.
*Roger J Kerr is Executive Chairman of Barrington Treasury Services NZ Limited. He has written commentaries on the NZ dollar since 1981.