By Phil Lynch
A special welcome to those who signed up for the ‘Week Ahead in FX Markets’ during the CFO Symposium 10 days ago. For those that were not able to attend the event, you can find a video of the interview I had with Bernard Hickey further down in this email, and the slides can be found by clicking here.
This week ahead will be a big one for the New Zealand dollar, with several key economic and central bank announcements to come on top of continued political interference.
One can be forgiven for being a little confused over the outlook for the New Zealand dollar. On one hand, we have GDP numbers beating expectations and showing our economy is growing at a respectable 2.8% annually. The solid GDP number last week managed to lift the kiwi off its lows and should keep the New Zealand dollar well supported this week. On the other hand, the upcoming Business Confidence data on Wednesday will remind that not all is well in New Zealand. First up some good news.
Over the weekend, global credit rating agency Moody’s has reconfirmed New Zealand’s AAA credit rating and continued with a stable outlook. Moody’s commented on the Coalition Government’s dedication to fiscal discipline. This is a positive for New Zealand, and for the NZD – but only time will tell if this supports the kiwi’s recent buoyancy.
For those that have been following my weekly outlooks – you may recall my thoughts on Business Outlook data – in that it is third tier data, it does not represent output and has had an unfair impact on the kiwi. This week we get to see if the terrible levels seen in August have recovered at all.
With a reading of -50.3% for Business Outlook, with the Own Activity outlook at +3.8%, it is hard to see confidence readings getting any worse. So, what are the implications for the NZD? In my view – I think that the emphasis that has been placed on confidence by markets has done its dash. It is difficult to see the number getting any worse (from the -50.3% currently). Perhaps any sort of improvement from that will support a stronger focus on output data (like the GDP), and RBNZ policy settings – like Thursday’s OCR announcement.
This Thursday sees another important OCR announcement from the RBNZ Governor – one that will set the tone for the rest of 2018 and help to clarify the murky position that the bank has developed recently. The current stance of the RBNZ is that the next move in the OCR is equally balanced – up or down. In general, FX markets have viewed this as a dovish sentiment – and skewed bets towards the next move being a cut.
Personally, I believe that RBNZ Governor Orr is not intending to send a dovish signal to markets but is simply being more open, pragmatic and frank about the current situation. You could say he is just adding a bit of personality to the role of Governor, which has certainly been missing from his predecessors.
For a long time, the RBNZ outlook has been neutral – well before Orr was Governor. In fact, inflation has been sitting towards the bottom (or even under) the RBNZ’s target of 2% for every quarterly announcement of inflation data (except one) since September 2011. So when Orr says – “the next move is equally balanced”, he is merely pointing out the obvious.
Whilst markets are still sensitive to central bank announcements, one thing that is for certain – is that our own OCR will be kept on hold at 1.75% on Thursday. It will likely be kept on hold for a very, very long time (well into 2020). The implications of this are reasonably straightforward – there will be limited focus on RBNZ developments and more focus on international developments – in particular, the US Federal Reserve.
On Thursday morning, just three hours before the RBNZ decision is published, the US Federal Reserve will hike their Fed Funds Target Rate range to 2.00-2.25%. In effect, this puts the US dollar at 0.50% premium to the kiwi, and we are only part way through this cycle.
This hike has been fully priced in by FX markets, so we are not expecting a huge plunge in the NZD/USD on the back of this announcement. However, as always, there is uncertainty about the future pace of rate hikes. Current expectations are for another hike in December, and another three hikes in 2019, which takes the effective rate to 3.00-3.25%. Beyond the 3.25% level is anyone’s guess – but there is a sense that things might start to unravel a little in the US by the end of 2019, and that 3.25% might be where the Fed stops. For now – the US economy is performing very well (outside of the mountains of debt they are raising).
Rising US interest rates are not just at a central bank level. They are also apparent in debt markets – where US public debt now attracts a higher interest rate than New Zealand debt. More on this can be seen in the video below. This rise in US debt yields is likely to fuel demand for the US dollar relative to the New Zealand dollar over the long-term. So whilst I might be bullish on the outlook for the New Zealand dollar short-term, there will be significant demand-side downward pressure on the flightless bird over the coming 12-18 months.
Last week was another fascinating week in the trade war sage – with Trump going ahead with a further 10% tariff on $200 billion of imports from China. Further to this, he plans to add a further 15% to this in January 2019. China has retaliated with tariffs on $60 billion of imports from the US. Is anyone else feeling fatigued trying to comprehend all of this? I get the sense that markets are starting to show the signs.
The reality is that the trade wars are dragging on and last week’s announcements failed to stir the expected reaction. The US dollar did not perform well, and a risk-on sentiment was carried through the week. It appears markets are becoming more and more comfortable with trade war developments and the uncertainty is not feeding into markets.
The largest currency rise since Friday came from the NZD/GBP – which climbed 1.2% to finish just shy of 0.5100. This was on the back of fears that the UK would leave the EU without a trade deal. British Prime Minister Theresa May said on Saturday the European Union must supply an alternative Brexit proposal, saying talks had reached an impasse after the bloc’s leaders had rejected her plans without fully explaining why. This raises the stakes for another one of those ‘market events’. On the back of the Brexit vote, the NZD/GBP climbed as much as 20% in a matter of days. There is concern that a no-deal Brexit will lead to further losses for Sterling.
Key market announcements this week kick off from Wednesday, with a steady stream. The highlight for me will be US Consumption data on Saturday morning. This data includes the PCE Deflator – a key inflation measure followed by the US Federal Reserve when setting the FFTR.
If you are interested in watching my discussion with Bernard Hickey from the CFO Symposium on key currency market themes, NZD forecasts, and how to manage FX risk, you can watch the video below. Note you may need to get a coffee beforehand as we get into the depths of the NZD and the video lasts for almost 40 minutes. I hope you enjoy it.
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