Summary of key points: -
- 'Buy the rumour, sell the fact' - FX market response to spectacular US jobs numbers
- Constraints on the NZ economy are being slow to be recognised
'Buy the rumour, sell the fact' - FX market response to spectacular US jobs numbers
Global foreign exchange markets had been expecting a strong increase in US jobs over the month of June following the disappointingly lower than expected employment numbers in April and May. The US dollar strengthened over the course of this last week in expectation of a stellar outcome. A large increase was certainly delivered when the June Nonfarm Payrolls number came in at an increase of 850,000, considerably above the 706,000 prior consensus forecasts. US workers returning to jobs in bars, restaurants and hotels accounted for a massive 343,000 increase in hospitality jobs alone. Other employment increases were in education, services and manufacturing industry sectors.
Further US dollar gains could have been expected on the result as the US economic rebound continues with some gusto and the Federal Reserve would be forced to raise interest rates earlier.
Well, that was the theory of how things should occur in the FX markets with “cause and effect” paradigms always holding true, right? Not on this occasion.
The US dollar weakened back against the Euro following the jobs data release and the Kiwi dollar reversed engines form a low 0.6950 prior to the release to close at 0.7025. The EUR/USD exchange rate traded to a low of $1.1820 immediately when the jobs figures hit the media wires on Friday 2nd July, however recoiled to $1.1865 at the close. The extent of the reversal back up in the Kiwi (0.75 cents) does appear to be overdone in comparison to the very minor pullback in the US dollar to $1.1865 against the Euro.
There are two explanations for the positive US jobs news not delivering immediate and further NZD weakness against a stronger USD value (as was widely anticipated): -
- FX market speculative positioning ahead of the announcement was such that much of the USD buying took place beforehand, resulting in the classic “buy the rumour, sell the fact” outcome. The unwinding process of these long USD market positions entered in the lead up to the data release does not normally last very long. We should still expect the EUR/USD to continue to lower levels below $1.1800 (stronger USD) over coming weeks and months as the US economy outperforms all others for the meantime.
- The equity markets reacted positively to the strong jobs figures as there was enough in the overall data to suggest that the Fed would not have to adjust their monetary policy stance/timing as a result. Whilst the headline increase of 850,000 jobs was certainly a big positive, the unemployment rate unexpectedly rose from 5.8% to 5.9%. On top of that, wages only increased by 0.30% for the month and +3.6% over the year, not suggesting an emerging and dangerous wage-price spiral. The equity markets concluded that the combined jobs data was a “goldilocks” result, i.e. just about right for everyone.
The USD side of the NZD/USD exchange rate equation continues to totally dominate the movements and direction. Therefore the greater probability still has to be on the side of a lower NZD/USD rate below 0.6900 over coming weeks as the US economy continues its rapid transformation back to full noise, post the Covid enforced restrictions.
The impressive recovery in US employment numbers was expected by the Federal Reserve. What is currently not expected by the Fed is that US inflation increases are more permanent in nature and prove not to be “transitory” at all. The next read we will have on this front is the June inflation figures being released on 14th July. Current forecasts are for a 0.50% increase for the month, lifting the headline annual rate to 5.70%. Oil price increases, freight/shipping cost increases and global shortages of micro-chips all appear to be much more permanent and will not be suddenly unwinding in a few months.
The markets will be examining the Fed’s FOMC meeting minutes being released on Thursday 8th July for any guide on their thinking on the “temporary or permanent” great inflation debate.
Constraints on the NZ economy are being slow to be recognised
Locally, the same issues of significant cost increases for oil, electricity, gas, freight and shortages of many products due to the micro-chip problem have combined to send expected price increases sky high in the latest ANZ survey of business confidence.
The RBNZ are grappling with the exact same issue as the US Federal Reserve, will these price increases stay or reverse within a few months? The evidence is mounting that the answer will be the former and therefore the NZ interest rate market is now pricing-in OCR increases in mid-2022, much earlier than the previous timing. The ANZ bank themselves are confidently predicting the first OCR increase before the end of 2021. It would require some spectacular GDP growth numbers in the June and September quarters (well above already overly optimistic RBNZ forecasts) to convince the RBNZ to lift interest rates that early. The RBNZ would need to see more permanent “wage-push” inflation emerging (as would the Fed in the US) before bringing forward the timing of their first interest rate increases.
Our view remains unchanged, there are just too many constraints on the NZ economy at this time to produce the higher GDP growth trajectory this year that the RBNZ and the banks are forecasting. The constraints on increasing productive output in the NZ economy at this time being listed as follows: -
- Severe shortages of workers. Just how reliant the NZ economy is on seasonal and permanent immigration is now very plain to see. Most private sector industries cannot increase output as they cannot hire the additional workers required. In the public sector, the nurse recruitment intake is way down due to the borders being closed to immigrants. The Government’s revised immigration policy is exacerbating the problem and is now inflicting not only harm to the economy but delivering sub-standard services in the health sector. After more than 12 months to prepare for increased demand for immigrant workers with expanded MIQ facilities, the Government has sat on their hands and done nothing.
- Severe shortages of export storage capacity. Cool stores are full, reefer containers are full and the ship visits (sea freight) to New Zealand continues to fall. The supply chain for our export industries is largely broken and will not be fixed anytime soon.
- Government enforced environmental and regulatory changes (water, carbon, land-use etc) on the agriculture sector is constraining production increases that would normally occur. Milk prices above $8/kg milk solids should stimulate increased investment in dairy production, however that is not happening for the reasons cited above. The environmental zealots that dominate regional councils across New Zealand need to take some accountability for their actions. The flooding of productive farmland in mid-Canterbury recently was partly due to the regional council ceasing the build and maintenance of shingle stop-banks on passive rivers that turn to torrents in severe weather events.
The current Government is certainly not recognising the above constraints on the economy, and it is debatable whether the RBNZ has an up-to-date understanding of these major economic issues. The bank economists seem to believe that the economy will grow strongly on house price increases and higher consumer spending coming off the back of that. No sustainable wealth is ever created by buying and selling existing assets with each other. New Zealand’s economic and wealth dependency is based on what we grow to sell to the rest of the world and right now it is difficult to increase that production.
At some point in the future when the FX markets return to focus on New Zealand factors to determine the value of the Kiwi dollar, they may well conclude that our GDP growth has been well short of all the forecasts due to the economic handbrakes listed above.
*Roger J Kerr is Executive Chairman of Barrington Treasury Services NZ Limited. He has written commentaries on the NZ dollar since 1981.