By Roger J Kerr
The NZD/USD exchange rate reached a high of 0.7220 last Friday as the markets unwound some of the Trump rally and the US dollar was sold back against the major currencies.
The higher levels were not sustainable and as the forex markets approached the President Trump inauguration ceremony and speech the US dollar recovered, sending the Kiwi dollar back down to 0.7130.
If financial and investment market participants were looking for more vision, policy insights/detail and momentum for the US economy from the Trump inauguration speech they would have been sadly disappointed.
The speech was the usual campaign bluster about “making America great again” and how Washington politicians and others have not served the people.
The markets will now want to see actual economic policy direction, decisions and action. These are happening with the unwinding of the Obamacare health system, however it remains to be seen how quickly the new Trump administration will move on infrastructure improvements, tax changes and trade protectionism measures.
The fiscal stimulus that could come from Trumponomics (tax cuts and Federal spending) will stoke US inflation and could cause the Fed to lift their interest rates sooner and by more than currently projected (three 0.25% increases this year).
The way Trump speaks you would think the US economy was in deep recession with decay and hopelessness across the land.
In fact, the opposite is the reality with near full employment and sustainable economic growth.
There is no crisis to fix, the Fed officials state that the US economy is performing near to its potential and thus any additional growth spurt stemming from Trump’s fiscal policies will be inflationary and thus lead to higher US interest rates and US dollar currency value.
The property speculator/businessman who is now President of the largest economy in the world is about to receive a sharp lesson in how the wider economy works. Trump tweeted last week that the US dollar is too strong which hurts their exporters and makes imports from China too cheap. However, the new economic policy initiatives he is about to embark on are all US dollar positive as the interest rate and GDP growth differential to Europe and Japan further widens.
The risk that the independent Federal Reserve may need to tighten monetary policy earlier and by more than currently planned (due to the Trump fiscal stimulus policies) may start to be seen by the US dollar returning to its post-November election rally, where it strengthened from $1.1200 to $1.0400 against the Euro.
The EUR/USD exchange rate is currently $1.0700 and a move back to the $1.0500 area seems likely as President Trump gets down to business and starts signing executive orders over coming days.
One minor problem is that his transition team has been very slow to get the Cabinet members officially appointed through the approval process.
If the Trump big talk is followed up by action then the greater likelihood is that the US dollar will get back on its strengthening path and the NZD/USD rate will return to below 0.7000.
A lack of action will see impatience in the FX markets and the Trump rally of a stronger dollar will fizzle out. Under this scenario the Kiwi dollar will remain in the 0.7100/0.7200 trading range over coming weeks/months.
European interest rates appear set to remain at the zero/negative levels for some time yet as the ECB see no emergence of inflationary pressures.
The Australian dollar has recovered strongly to 0.7550 over this last week from lows of 0.7150. The Aussie was slammed down hard after the Trump victory as the anti-China trade rhetoric in the Trump campaign was seen as negative for Chinese manufacturing exporters and thus negative for the Australian economy (who supply the raw materials).
The higher metal and mining commodity prices since December were at odds with the lower AUD exchange rate value, thus the recent realignment of the divergence has not been too surprising. However, the poor Aussie Government debt and fiscal deficit situation, that could still lead to a sovereign credit rating downgrade, does overhang the Aussie dollar. Thus further AUD gains above 0.7550 to the USD seem less likely.
The NZD/AUD cross-rate has pulled back to 0.9480 from highs of 0.9650 when the Aussie was at its weakest point. In the short to medium term, the only change that could cause the NZD/AUD cross-rate to fall further to 0.9300/0.9200 would be dairy commodity prices falling away, whereas iron ore and copper prices remain stable.
The GDT auctions over the next month will be crucial for the outlook for dairy prices over the remainder of this year. Any hint that the Chinese are reluctant buyers of imported milk powder over coming GDT dairy auctions will see a slide in the WMP price and the Kiwi dollar should follow.
Do not expect too much impact on the NZ dollar from the RBNZ over coming months.
They are “on hold” with monetary policy changes and the next MPS/OCR review on 9 February should be a non-event.
However, the RBNZ will have to comment on why the overall value of the NZ dollar, the TWI Index, is still at very high levels of 78.56 despite repeated interest rate cuts and a stronger US dollar on global FX markets.
Two factors this year will not be as positive for the Kiwi dollar as they were last year. Namely, the attractiveness of NZD carry-trades from hedge funds and Chinese capital outflows into NZ property assets slowing up as new regulations in both China and NZ have an impact.
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