img NZ
img AUS
img CDN
img US
Call us now: 0800 00 56 17
imgExpress Login

The Week Ahead in FX Markets – Flightless bird goes to ground | Key themes for the rest of 2019

Published August 19, 2019

By Phil Lynch

The NZD/USD opens lower once again this week, falling to its lowest level in 12 days since the RBNZ surprised markets with the 0.50% cut to the OCR. The move lower in the NZD indicates that the flightless bird is struggling to regain any strength, in a market that is increasingly worried about a broader global economic downturn.

This week ahead brings an important event: The Jackson Hole Symposium. This event sees central bankers, academics, economists and media come together from around the world to talk about “Challenges for Monetary Policy”. There will be at least a couple of key speeches from this event, which will help clarify at least one burning question: Is the Fed’s recent rate cut really just a ‘mid-cycle adjustment’, or is it the start of a rate cutting cycle?

Today I break down the key themes impacting markets and provide an update on my view on the NZD/USD.

Key Theme: Central Banks Cutting Rates

Right around the world central banks are cutting rates, to stimulate their economies which are struggling to recover. Debate is raging as to whether the recent downturn is cyclical or structural. What we do know is that central banks around the world are starting their rate cutting cycles from a very low base. This makes rate cuts less effective and opens the possibility of atypical policy decisions like negative interest rates or quantitative easing. This raises more questions than answers, in particular:

  • What atypical measures will the RBNZ take if required, and does it have the resources to manage these?
  • What impact will this have on the NZD which typically suffers in times of uncertainty?

The other burning question is if the US Federal Reserve is going to follow suit and cut rates more aggressively. They now have some of the highest rates in the Western world. Both markets and President Trump are urging them to take a more aggressive approach. We will likely find out this Saturday morning if:

  • The Fed’s recent rate cut was just part of a “mid-cycle adjustment” or if the Fed are now looking to shift their stance
  • How many rate cuts we can expect from the Fed when they announce their next rate move in 31-days. Markets have priced in a 71% chance of a 25-basis-point cut, and a 29% chance of a 50-basis-point cut

It is difficult to predict which way the Fed will go. Globally, central banks are cutting interest rates to get ahead of the global economic downturn. The Fed, however, have record low unemployment and inflation close to their target. It may take further weakness in economic data to see the Fed really shift to a rate cutting cycle. My feeling is that they will need to start playing catch up as there are too many risk factors to keep rates higher.

Key Theme: Trade Wars

The trade wars are ongoing, and this is having a “huge” impact on economic performance around the world. Arguably those most affected are the US farmers, who are no longer able to export their product to China. But the real problem for markets is the uncertainty that these trade wars bring. The uncertainty makes it difficult for business to make decisions, as they do not know if their goods will get caught up the war.

So far in August, the trade war has seen:

  • The US announce another 10% tariff on the remaining USD 300 billion of goods coming from China, which will come into effect on 1 September
  • The US declare that China is a currency manipulator
  • The US announce a delay on the 10% tariff to now come into effect on 15 December
  • China to suspend purchasing of certain US agricultural products
  • And just moments ago, President Trump has announced he does not want to do business with Chinese tech giant Huawei, because it is a “national security threat”

The trade war so far has seen the US impose tariffs on USD 250 billion worth of Chinese goods, with China imposing tariffs on USD 110 billion of worth of goods.

Ironically the trade wars will likely take a huge toll on Trump’s chances at the 2020 US Presidential election. The economy, which he prides himself on, is struggling under the threat of ongoing trade wars. Those that are most affected are farmers – who are a big part of Trump’s support. Trump may need to find a resolution to the trade war to satisfy his voting base – or he may risk losing the 2020 election. For this reason – I suspect Trump will start to work harder to find an agreement with the Chinese.

Key Theme: Brexit

I have not talked a lot about Brexit lately, but there is a very high likelihood that the world’s 5th largest economy (by country) moves into recession later this year, if they do in fact leave the EU with no deal. Many economists are now expecting the GBP/USD to move to parity (from 1.21 currently). With the GBP at parity, the NZD/GBP could be in the 0.63’s. But more importantly, the economic unrest this causes could impact the global economy could see the NZD under immense pressure.

Opinion: Bearish view shifting to neutral

I have been bearish on the NZD/USD for most of 2019, given the mix of economic pressures around the world. However, I am now cautiously shifting to a more neutral stance on the NZD/USD (despite the huge array of risks outlined above), and I suspect that 0.64-0.65 represents a fair range for the NZD/USD for the rest of 2019, given current conditions. Here is why:

  • Recent rate cuts have seen us drop faster than most expected, and the NZD is now ahead of the game
  • The US Fed should move to cut rates, and with some of the highest interest rates in the Western world, they might just shift to a more dovish stance
  • The RBNZ should, and probably will, exercise caution from here, and leave rates on hold. Their rate cuts are arguably unnecessary given current economic output. Their aggressively dovish stance has sent shock waves through NZ business – and that may have been noted by policymakers
  • Our neighbours in Australia are due to bounce back. Iron ore prices are through the roof, and the Aussie dollar is near record lows. This is producing record gains for Aussie mineral exporters and supporting their economy. Our dollar often follows the AUD

Caveat: The ingredients for a more severe global economic downturn remain, but they are yet to come together to cause a widespread global recession like what was seen during the GFC. If these were to come together then the NZD is likely to be one of the biggest losers, as has been the case at every major global economic downturn in history.