By Roger J Kerr
Finally, it seems the US Federal Reserve will belatedly come to the rescue of RBNZ Governor Graeme Wheeler and a stronger US$ exchange rate will assist in the quest to return New Zealand’s inflation rate to the required 1% to 3% band.
The very clear signal from the Federal Reserve Chair, Janet Yellen at last weekend’s Jackson Hole speech was that US economic conditions have improved to the point that a 0.25% interest rate increase is very much “in play” for the 21 September Fed meeting.
Under the proviso that US jobs expand for August by greater than 180,000 on 2 September, the probability of a Fed hike in September will increase to above 50%. The FX markets should now price the US dollar stronger against all currencies in the lead up to the August jobs figures and 21 September Fed meeting. Rising US interest rates against money printing monetary policies in Japan and Europe underpins the next phase of anticipated US dollar strength.
Already the US dollar has made gains against the Euro after the Yellen signal from $1.1300 to below $1.1200. Further US dollar gains have to be expected over coming weeks against the major currencies, as well as Asian and emerging market currencies. In this environment the NZD/USD rate should come under increasing downward pressure to below 0.7200 and eventually 0.7000, as it depreciates in line with all other currencies against the resurging USD.
As was expected, Janet Yellen has finally run out of excuses not to increase US interest rates. All year she has managed to find a new reason not to raise rates. However, now consistently stronger US economic data (especially employment) is outweighing global financial market volatility and lower oil prices that have kept US inflation at lower than expected levels. The markets are now stable and oil has stabilised at a higher US$40 to US$50 per barrel range.
One very good reason why the Fed want US interest rates higher in 2016 is that if the global economy is hit with another shock, the US will have the ability to cut interest rates to restore market confidence. By not raising rates when the economic rationale demands it, the Fed run the risk of having now ammunition to fire when they might need it at a later date.
The Yellen signal last Friday is a significant event and now it is expected that the mood and sentiment in the global forex markets will turn much more positively for the US dollar. The growing prospect of US interest rates increases over the remainder of the year is not good news for US sharemarkets who have been dining out on zero interest rates for several years now. Typically, the NZ dollar depreciates in times of falling equity markets and “risk-off” global investor market sentiment.
The Kiwi dollar climbed to a high of 0.7370 just ahead of the Yellen speech, however was slammed back immediately to 0.7220 as the markets reacted to the Yellen speech. Prior to succumbing to renewed US dollar strength, the Kiwi dollar was pushed up through the 0.7300 resistance level by yet another RBNZ statement that sent the currency higher (instead of lower as the RBNZ have themselves have wanted to do for more than 12 months now).
Last week a speech on monetary policy by Governor Wheeler failed to express any concern that the NZ dollar had appreciated significantly since the 0.25% interest rate cut by the RBNZ on 11 August. The financial markets were conditioned by the RBNZ in late July to expect a reasonably aggressive monetary policy loosening over the remainder of 2016. Incomprehensibly, the RBNZ have seemingly deliberately under-delivered to that market pricing and the result has been a higher Kiwi dollar, rather than the desired depreciation.
In the 11 August Monetary Policy Statement and last week’s Wheeler speech, the RBNZ have miss-read the financial market sentiment/pricing and their statements have made life a lot tougher for themselves. If you keep on shooting yourself in the foot at some stage you might expect a decision not to pull the trigger of maybe move the foot!
Whilst continuing positive economic growth in New Zealand and the dramatic recovery in dairy prices are very positive factors for the Kiwi dollar, the exchange rate is a relative price to the USD itself.
For the first time in many months the direction of the US dollar looks much clearer cut for significant gains from current levels. The NZD/AUD cross-rate has retreated from highs above 0.9600 to 0.9550 following the Yellen speech.
The Kiwi dollar has outperformed the Aussie dollar over recent months, however the NZD/USD rate appears more over-stretched than the AUD/USD rate which has been stable around the 0.7600 region. Expect to see the trans-Tasman speculators now sell the NZD against the AUD, pushing the cross-rate back to the 0.9000/0.9200 area.
Roger J Kerr contracts to PwC in the treasury advisory area. 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