By Roger J Kerr
The fact that the US dollar has posted strong gains across the board against all major currencies on the back of stronger US jobs growth in October can be of no major surprise to the financial markets.
The stronger US economic data reinforces the forming view that the Federal Reserve will finally move to increase their interest rates for the first time in nearly a decade at their 17 December meeting.
The postponement of the Fed’s decision to raise interest rates from September to October to sometime later had previously casted doubt about their commitment and timing, the short-term interest rate markets in the US started to “price-out” the expectation that the interest rates would increase by 0.50% (from 0.00%) over the next 12 months.
The August and September monthly jobs numbers were on the weaker side of prior forecasts, however the October figures were a massive 271,000 increase in new jobs. As a consequence the US unemployment rate has reduced further to 5.00%, a 7 ½ year low.
The US dollar was always going to strengthen on official interest rate increases, the question has always been as to how much further the US dollar would go when it has already appreciated 25% in early 2015 (from 80.00 to 100.00 on the US dollar currency index) on the expectation that US interest rates would increase by 0.50% by the end of the year.
After trading in a sideways fashion between 95.00 and 98.00 on the Index since March, the US dollar has lifted again to 99.20. It would still be this writer’s view that 80% of the gains the USD was likely to make on increasing interest rates have already happened and a second massive 20% plus appreciation of the US dollar from current levels seems unlikely.
The EUR/USD exchange rate has returned to the $1.0500 to $1.1000 trading range after the slightly weaker US economic data through August and September had forced a marginally weaker USD in the $1.1000 to $1.1500 trading range.
Whilst some global investment banks are continuing to forecast the US dollar to strengthen a lot further to below $1.0000 against the Euro over the next 6 to 12 months, it would seem unlikely that the interest rate markets in the US would price another 0.50% increase to 1.00% so soon to justify that additional US dollar strength.
Federal Reserve Chair, Janet Yellen has made it very clear to the financial markets that the pace and extent of US monetary tightening will be considered and measured i.e. rather slow. In terms of timing, it would appear that the Fed would want to action the second 0.25% increase by mid-2016 after the first 0.25% increase in December. They would not wish to be increasing interest rates through the second half of 2016 when the US Presidential election campaign is in full swing ahead of the November 2016 vote. On this reasoning another major push stronger in the USD seems a lower probability.
The stronger US dollar on the world stage is not all good news for the US economy.
US manufacturing data has been slowing of late as the large industrial manufacturing companies (e.g. John Deere, Caterpillar) become less price competitive in export markets due to the stronger USD. On top of the currency headwind, these companies are also facing reduced energy/mining industry demand (due to lower energy and commodity prices) and slower infrastructure growth in China. Most of the recent growth and jobs increases in the US economy have been in the services sectors, not the industrial/manufacturing part of the economy.
If the US dollar itself does not record significant further gains against all currencies from current levels of $1.0730 against the Euro, it is difficult to see the NZD/USD exchange rate depreciating to below 0.6000 as all of the local banks have been forecasting.
Some of those pessimistic NZ dollar forecasts were formulated back in June and July when sharply lower dairy prices prompted forecasts of the NZ economy slumping into recession.
Much has changed since that time.
Local business and consumer confidence levels have rebounded as it was belatedly realised that the mid-year pessimism was a massive over-reaction to the lower dairy prices, global share market volatility and Chinese economic concerns. Dairy prices have recovered (although lower in the last two GDT auctions) and the global sharemarket and Chinese risks have not materialised.
All sectors in the NZ economy outside of dairy have remained robust with tourism and services particularly strong. The Reserve Bank of New Zealand’s next monetary policy statement on 10 December should paint a more upbeat picture of the NZ economic outlook with global risk factors reducing.
The rapid run up in the Kiwi dollar from 0.6300 to 0.6850 against the USD over the first half of October was seen as “too far, too fast” at the time. The return to 0.6500 on the stronger US economic data over recent weeks is a fairer reflection of the positive and negative forces on the NZ currency value. Stability in and around this current 0.6500/0.6600 level over coming months appears more likely than appreciation to 0.7000, or depreciation to below 0.6000.
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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