By Mike Jones
It’s been a rough road for the NZ$, scuttled yesterday afternoon as S&P delivered a surprise ratings outlook reduction. Surprising in part because S&P officials seemed fairly relaxed about NZ when they were recently in the country, it would appear they might have a very good poker face.
Standard & Poor's points its finger firmly at New Zealand's significant net international liabilities and prospect of a rising current account deficit as its reason for concern. We think its worries in this regard are well justified and are at the heart of the current debate surrounding New Zealand's savings shortfall. The fact that the fiscal outlook has deteriorated has added to this angst. It’s one thing to have a current account deficit but it’s another to have twin deficits – and this is where New Zealand currently finds itself.
That said one could question the timing of the announcement and S&P’s understanding of the New Zealand economy. To start with the net international investment position has been steadily improving since March 2009 and while this does not mean that the recent trend will remain intact it is questionable that the international short fall will grow more than previously thought by the rating agency.
Moreover, S&P points to New Zealand’s vulnerability “stemming from its open and relatively undiversified economy”, another truism but hardly news. The most bemusing aspect of yesterday’s release, however, was that the rating agency believes that the New Zealand economy will only grow 1.6% in calendar 2011. This is miles below our own expectation of 3.5%, the Consensus view of 3.2% and the Reserve Bank’s miserable 2.5% projection. Where this number came from is anyone’s guess.
Of course, given the track record of the ratings agencies one questions their views anyway but alas they have to be swallowed. In this light it is interesting to note that New Zealand is seen as being vulnerable when the US and UK appear to be getting away with fiscal murder (at least in a relative sense given their AAA ratings as opposed to NZ’s AA+).
A surprise it all may be, but, alas, the warnings are real. New Zealand and New Zealanders do have to face up to the fact that the chickens are finally coming home to roost. In these uncertain times countries’ weak points are being gone over with a microscope. S&P is giving us a timely warning that we must now front these issues. If we choose to do so ourselves it will mean a period of adjustment accompanied by lower-than-desired growth. If we don’t the world may do it for us.
Real money demand sought out the dip in the NZ$ yesterday evening, with some technical traders also keen buyers at times as the NZ$ recovered through the London morning and reflected broader FX market sentiment which was still favouring "short" USD positions following the Irish application for EU/IMF assistance. However, the NY session has been a different kettle of fish; again it's to the ratings agency we look for a catalyst. Moody's Investors Service said it may lower the credit rating of Ireland by more than one level, and so we open this morning to the NZ$ at 0.7700, the AU$ at 0.9835 and the EUR at 1.3590 all near overnight lows. Key support appears to remain in the 0.7650 area for the NZD.
This afternoon (3:00pm) we have the RBNZ quarterly survey of expectations. Any increase in the 2-year-ahead CPI inflation expectations in the RBNZ survey, from Q3's read of 2.6%, will be most unwelcome. Note also that Tuesday's RBNZ survey will divulge respondents' picks for a number of other key macro-economic variables, including quarterly GDP.
The relief rally with which we started our week lasted for no more than a few hours of the overnight session. Although there’s no word on the size of the Irish rescue package private sector estimates put the total somewhere in the €80-100bn range. The Irish Government has attempted to portray the funds as merely a contingent loan to the banking system but this is rightly fooling no-one; it is the Government which first underwrote the banks and which has now run out of cash to continue its support operation.
More disturbing for investors are the fresh doubts which now surround the banks’ stress tests. On July 23rd, the Committee of European Banking Supervisors (CEBS) reported on the health of banks across the continent. Both Bank of Ireland and Allied Irish Bank were expected to have Tier 1 capital ratios of 7.1% and 6.5% respectively. Less than 5 months later, the Irish State has run out of funds with which to guarantee these institutions. Moody’s Investor Services delivered the final blow for sentiment when it said it may lower the credit rating of Ireland by more than one level. Given the huge degree of correlation and co-dependence across asset classes, falling equity indices have translated into risk FX losses against the US Dollar.
Offshore tonight there's various German PMI & Consumer Confidence updates as well as US GDP, home sales releases and the Richmond Fed's Mfg Index. This time tomorrow morning there’s the release of the FOMC minutes where any sign of a more serious split from US policymakers could further hasten profit-taking in both FX and global stock markets.
* Mike Jones is part of the BNZ research team.
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