Roger J Kerr says just why New Zealand would be taking up such an aggressive foreign policy stance against our largest export/import trading partner, China, beggars belief

Summary of key points: -

• Probability of a “hard landing” for the US economy increases
• PM’s foreign policy stance against China potentially hurting the NZ economy (and dollar)

Probability of a “hard landing” for the US economy increases

Current foreign exchange market pricing, in maintaining the US dollar value at its record highs over recent weeks, reflects total belief by the currency markets that the Federal Reserve can beat the high inflation without sending the US economy into recession i.e. orchestrate a “soft landing” to the economic slowdown.

Our view continues along the consistent theme that the FX markets have too much faith in the Fed to get this right. The markets stand to be massively disappointed. Already, there is a stack of evidence that the US economy slowed abruptly in May, and it appears that the rapid slowdown to activity levels across the US economy has continued in June.

On top of the weaker than expected US retail sales, housing starts and industrial production data for May, the latest ISM manufacturing survey for June was also well below prior forecasts, a 53.0 actual result compared to a 54.9 forecast and 56.1 last month. The Federal Bank of Atlanta GDP growth predictor (GDPNow) projects that the US economy will contract by 2.1% in the June quarter. Added to the 1.6% decrease in GDP in the March quarter, it appears that Jerome Powell at the Fed will again be well wide of the mark in stating that the US economy remains “robust” to handle higher interest rates. The Atlanta GDPNow index has been very accurate against actual GDP growth outcomes over the years, so a “hard landing” is looking increasingly likely.

The weaker economic data has caused the US Treasury bond market to sharply reverse in sentiment and direction over the last two weeks, the 10-year yields plummeting to 2.88% from 3.50%. The bond market is now pricing-in a peaking in US inflation and reflecting a higher probability of economic recession. It is only a matter of a very short time before the FX markets reverse their bullish USD positions and sell it down. The USD currency index closely follows the 10-year Treasury bond yield in direction. The sharply lower bond yields suggest the USD Index is about to reverse from the current 104.80 to somewhere closer to 100.00. A 5% depreciation in the USD over coming weeks, would see the Kiwi dollar clawing its way off the bottom at 0.6200 to a value closer to 0.6500.

Should the lower bond yields feed into a lower USD, the EUR/USD exchange rate, which has remained under pressure around the $1.0400/$1.0500 mark, may start to challenge the downtrend resistance line and 30-day moving average line at $1.0600 (refer chart below). A recovery in the Euro towards $1.0800 would pull the Kiwi dollar up to 0.6500 and would signal a turning point towards a weaker USD going forward.  

It may need the Fed to change their rhetoric around the strength of the US economy, before the FX markets are convinced the US dollar is overvalued vis-à-vis the economic outlook. A piece of economic data coming up that may force a Fed moderation in tone is the June monthly jobs figures on Friday 8th July. New jobs for the month could be well below the +270,000 consensus forecasts, and also well down on recently monthly increases. Following the jobs data, the next key data-point is US CPI inflation figures for the month of June on Thursday 14th July. An annual increase in inflation below the 8.60% recorded for the 12 months to the end of May will be negative for the US dollar. Locally, the focus will be on the RBNZ’s interest rate review on 13th July. No surprises there, with another 0.50% OCR increase (which is already well priced-in to the market).  

PM’s foreign policy stance against China potentially hurting the NZ economy (and dollar)

The post-Covid era in the NZ economy in 2022 was supposedly going to see a bounce back in activity and confidence about the future. For a combination of reasons, the direct opposite is occurring with business and consumer confidence plunging to new lows and everyone pretty grumpy. Household finances are under pressure from high inflation and rising mortgage interest rates and businesses are frustrated with the shortages of workers. Our view has been that the NZ domestic economy may well go into recession this year, however the export economy continues to do well and once again will pull the overall economy through. How the economy has been able to make up for the loss of international tourism and international education foreign currency receipts over recent years remains something of a mystery. Higher export commodity prices have compensated to some extent.

The loss of those foreign currency receipts for tourism and education may partially explain why the Kiwi dollar has under-performed the Aussie dollar over recent months against the USD. As a result the NZD/AUD cross-rate nose-dived from 0.9700 last October to 0.9100 today. The lower volumes of selling foreign currency receipts, buying NZ dollars resulting in the weaker NZD exchange rate performance.

There may also be a second reason for the lack of interest to buy the NZ dollar at this time. A quick scan of the headlines across the Bloomberg and CNBC financial/investment news websites over this last week reveals numerous news stories featuring New Zealand and its veiled messages towards China. The Prime Minister’s recent visits to the US and Europe has seen an unheralded and abrupt change to our previous “independent, non-aligned” foreign policy position. Without a mandate from anyone, Jacinda Ardern has signed up to some partnership arrangement with the US for the Pacific and invited NATO and the UK to take more of an interest in the Pacific against China’s ambitions in the region.

Just why New Zealand would be taking up such an aggressive foreign policy stance against our largest export/import trading partner (China) beggars’ belief. It could just be that the PM likes to say all the right things at these international jollies to get the photo-ops with Biden, Boris, von der Leyen, Macron and Trudeau. Even the trumpeted Free Trade Agreement with the EU only results in chicken-feed benefits to the NZ economy. Looks like they gave us some crumbs for kiwifruit, seafood and wine to keep their protectionist policies on meat and dairy.  

The implications for the Kiwi dollar are negative as offshore investors observe New Zealand going down an unexplained path of potentially upsetting the Chinese to the point that they ban some of our exported product, as they have done with Australia. The PM always states that it is the export sector that has got the NZ economy through the rough Covid period, however her recent foreign policy actions are jeopardising that very sector. It makes no sense at all!

For the sake of social and economic wellbeing within New Zealand, the Prime Minister would be better off spending her time leading a trade mission to China (to repair relationships), promoting New Zealand to the world as a place to immigrate to as we have a chronic labour shortage and spending a couple of weeks in South Auckland with community/charitable agencies to understand the causes of the child poverty she so publicly vowed to reduce.

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