By Roger J Kerr
The Kiwi dollar has traded within a much tighter range between 0.6450 and 0.6650 against the USD through the month of November. But such a narrow range by Kiwi dollar standards is unlikely to be repeated over the month of December.
Volatility is widely expected to increases as the forex markets digest and react to two crucial central bank monetary policy pronouncements coming up from the Reserve Bank of New Zealand and the US Federal Reserve.
The RBNZ’s Monetary Policy Statement on December 10 sits on something of a knife edge with the interest rate market’s pricing suggesting a 50/50 call on whether they cut the OCR again to 2.50%.
The argument for a cut at this time is that historical inflation remains below the RBNZ’s minimum speed limit of 1.00% and some say it will not increase much over the next 12 months.
The case for a “no cut” decision appears stronger for the following reasons:
- The NZ economy has proven to be stronger than what the RBNZ expected in September. Latest lead-indicators for the economy point to GDP growth returning to above 3.00% next year.
- The RBNZ need to wait and observe the impact of tax/regulatory changes on the runaway Auckland residential property market before acting again on monetary policy. Why would they fuel that bubble further with even lower mortgage rates?
- The RBNZ need to wait and see whether the tradable inflation increases over coming months in line with the much lower NZD/USD rate after importer legacy hedging has run out (as the RBNZ have been forecasting).
- The global economic and financial/investment market environment is a whole lot calmer and more certain than what it was back in September when the RBNZ had had worries about China and world economic risks. Those risks have just not materialised.
- RBA Governor Stevens summed the reality of the situation rather well last week, stating that why would he adjust monetary policy so close to Christmas – better to wait and see.
- Dairy prices, whilst very volatile, are above the level that the RBNZ expected for late 2015. The NZD/USD rate is bang in line with the level of wholemilk powder prices at USD2,200/MT. Very hard to argue these days that the NZ dollar is still over-valued.
- RBNZ Governor Wheeler has been waiting 18 months for the US Federal Reserve to increase interest rates and thus provide strength to the USD currency value and thus do some of the monetary easing in NZ for him. Why would he make a decision to loosen monetary policy further when the Fed will do that a week later?
The US Federal Reserve’s meeting on December 17 appears to be more clear-cut with the interest rate markets pricing a 75% probability of a 0.25% increase in the Fed Funds rate.
It would need to be a totally disastrous US jobs number later this week to cause the Fed to delay the inevitable any longer.
Our view is that the US dollar exchange rate value has already appreciated over the last 12 months in expectation of interest rate increase; therefore further significant USD strength after the announcement on December 17 seems unlikely.
Over the last 30 years on the four occasions when the Federal Reserve have tightened monetary policy with increases in the Fed Funds rate, the USD value has subsequently gone up once, down once and a combination “down/up” on two occasions (refer chart below).
Kiwi dollar gains will however be muted on a “no-cut” RBNZ decision as the accompanying rhetoric/guidance will still be that they remain with a monetary easing bias.
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Roger J Kerr is a partner at PwC. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com