By Phil Lynch
The New Zealand dollar hit six-month lows last week, trading as low as 0.6512 and pressure continues to mount. The kiwi is now in a clear downtrend and at the mercy of a more dovish RBNZ, and a strengthening US dollar. The big question is how low can the kiwi go? We know the kiwi is susceptible to:
This week ahead, key market events come in the form of central bank meeting minute releases, notably from the RBA, the Fed, and the ECB.
In the past 38 trading days, the NZD/USD has fallen more than 5.5%. It has clearly broken through key support levels around 0.6800. It has also developed a clear downtrend as demonstrated in the chart further below. The two key elements driving the NZD lower are a dovish RBNZ and a strengthening USD – which we need to assess further if we are to find out how much lower the NZD might move.
I was beyond surprised to see the RBNZ adopt such a dovish stance to monetary policy when they last met on 8 May. Despite record low unemployment and stable inflation within their target range, the RBNZ chose to lower the OCR rate to 1.50%. I don’t believe that rate cut was warranted, and as such I don’t believe the RBNZ will be cutting rates any further.
However – if the RBNZ does cut further, then the NZD will fall further. And there is nowhere near a consensus in markets. Markets are pricing in a 16% chance of a cut on June 26 and a 62% chance of a cut by November. There is even a 16% chance of seeing two cuts by November. Cuts of this magnitude will see the OCR enter new territory and this would weigh heavily on the NZD.
However, given the dovish outlook in market pricing being contrary to my neutral outlook, I can only conclude that the NZD is now undervalued and deserves to lift from these levels. However, there is enough uncertainty about what the RBNZ will do this year for importers to be extremely cautious in their approach.
The RBNZ’s impact on the kiwi is likely to be secondary to the movements in the US Dollar. The kiwi has long been susceptible to global markets and there are plenty of key items that could see the kiwi get battered. The kiwi tends to do poorly in times of heightened uncertainty and does well in times of global confidence.
Unfortunately for our importers – the forecast shows storms on the horizon – it’s just unclear how strong they will be. The key focus is the US-China trade war which does not have a clear end in sight. Most recently the US has announced that Huawei Technologies (the worlds largest telecoms equipment maker) will be blacklisted. Meanwhile China has stated there “must be a show of sincerity” for there to be meaning to the talks. The result is more global uncertainty, an environment which the NZD does not do well in. The US Dollar index has risen by almost 10% over the past 18-months and is trending higher.
In an unthinkable turn of events, it looks as though Australia has NOT changed their Prime Minister. I had been using the change in Australian Prime Minister as a reminder to change the batteries in my smoke alarm – but incumbent Prime Minister Scott Morrison has successfully retained his position. It is yet unclear if he will have an absolute majority, which means he is likely going to need the support of independents to successfully change legislation. However, his mandate is to maintain more of the same – an economically friendly environment for big business.
Markets had been pricing in some risk to the economy, with most pre-election polls expecting the defeated Labour party to be victorious. The Labour party was perceived as higher risk to the economic performance of Australia, so with that risk out of the way we might expect the AUD to recover somewhat – however that is more dependent on monetary policy than the government of the day.
The RBA meet in just over two weeks and are now widely expected to cut rates to 1.25%. Markets have priced in an 82% chance of rate cut on June 4 – but the outlook is that the Target Rate could get much worse throughout 2019. By December, markets have priced in a 36% chance of a cut to 1.0%, and a 24% chance of a cut to 0.75%. This is a big change for the AUD – which has seen the Target Rate stable since August 2016.
I was talking to two of our senior dealers in Sydney on Friday – and they have both quoted RBA commentator Terry McCrann via News Limited as someone with an excellent track record of calling RBA decisions correctly. McCrann has said the RBA rate cut next month is now “locked in”. This follows last weeks poor performance in the labour market numbers. This move has seen the AUDUSD fall to fresh lows well below the 0.7000 cent floor that had been supported for much of 2019.
We can be reasonably confident the RBA will cut rates on 4 June. However, like the RBNZ, I don’t believe another rate cut is warranted. In the case of Australia, this comes down to the fact that commodity prices are still booming, that the newly elected government will continue to support big business, and that export earnings will be supported with the lowest exchange rate levels seen in years. I believe this could be the lowest point we will see for the AUD this year.
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