By Roger J Kerr
The Reserve Bank of New Zealand (RBNZ) have been stymied in their belated attempt to drive the NZ dollar exchange rate lower to get inflation higher.
The US dollar on the world stage has depreciated, for the meantime, due to weaker than expected US GDP growth for the June quarter. Prior forecasts were for a 2.6% annualised expansion in the US economy, due to lower inventory build numbers the actual result was a disappointing +1.2% annual growth figure.
The USD was sold off against all currencies on Friday 29 July, the US currency’s index dropping from 97.0 to 95.5 as the forex markets reacted negatively.
The contribution of inventory levels to GDP growth numbers can be volatile and that appears to be the case for the June quarter.
All other US economic measures for jobs, retail sales, industrial production and manufacturing were much more positive in the second quarter compared to the first, so that is why the weak GDP level was such a surprise to the FX markets.
The markets have concluded that the US Federal Reserve will now take any consideration of an interest rate hike in their September meeting off the table completely.
Therefore, the US dollar has weakened from $1.1000 against the Euro to $1.1180. It was expected prior to this GDP release that the US dollar would continue to strengthen against the Euro due to rising interest rates in the US and a continuation of no inflation or growth in Europe, thus loose/loose monetary policy. Instead of heading south to below 0.7000 against the USD, the Kiwi dollar has abruptly reversed direction to 0.7200.
The NZD/USD depreciated from 0.7300 to 0.7000 when the RBNZ changed their stance on monetary policy settings and paved the way for further OCR cuts with increased bank lending controls on residential property investors. Those good intentions to push the currency lower have for the meantime been undone by global developments.
However, it does not mean that the USD will continue to weaken. US economic data is expected to print in a positive fashion over coming weeks/months, commencing with Non-farm Payroll employment data this Friday 5 August where forecasts of an 180,000 increase in jobs is likely to be exceeded.
Also thwarting the RBNZ intentions to generate a lower exchange rate has been the actions of the Bank of Japan last week.
They disappointed markets with a monetary stimulus package that was less than expected in quantum, as a consequence the Japanese Yen strengthened from 105.0 to 102.0 against the US dollar.
The only conclusion that can be drawn from these events is that the Japanese monetary authorities will realise their mistake in underwhelming the markets and take remedial action as the Yen has moved in the opposite direction to what they intended. The JPY/USD exchange rate will eventually trade back to 110.0 and not below 100.0 when the Bank of Japanese do phase two.
What is even more perplexing with recent financial and commodity market movements is that normally reliable correlations and relationships have seemingly broken down.
Oil prices have been falling over recent weeks as stocks increase and previous supply disruptions are worked through. The West Texas crude oil price has reversed 17% from levels above US$50/barrel in June to US$41.40 today. Normally, other metal commodity prices would follow oil lower and the US dollar would strengthen as it moves inversely to global commodity/energy prices.
Emerging market currencies such as the South African Rand and Mexican Peso have strengthened against the weaker US dollar, despite their commodity prices not improving. These currency movements do not add up and it can only be a short time before reality returns and we see a stronger US dollar re-emerging against weaker oil and commodity prices.
Here in New Zealand the return of the Kiwi dollar to above 0.7200 against the USD may prove to be short-lived. Further bad news for the dairy sector just has to follow with highly indebted dairy concerns struggling to keep the confidence of their bank lenders with the third year of incomes below annual costs. Offshore observers and investors in the NZ economy are more likely to be reducing their holdings when the extent of the dairy downturn on the overall economy is fully realised.
The local interest rate market is already pricing-in two 0.25% reductions to the OCR over the next few months.
Recent global events with the unexpected US dollar weakening would suggest that the RBNZ need to throw out the “steady and cautious” approach to monetary policy management and surprise the markets with a larger 0.50% cut to the OCR on 11 August. Another low survey of inflation expectations this week may be just the catalyst for them to reach a much needed bolder OCR decision.
The view of this column is that the recent losses by the US dollar on international currency markets will be short-lived and thus the NZD/USD exchange rate will pull back to the 0.6800/0.7000 range over coming weeks.
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