By Phil Lynch
The New Zealand dollar opens the week in strife, having succumbed to mounting pressure. The key drivers have been as follows:
The kiwi was down substantially across Q2 – here’s a quick snapshot showing just how far the kiwi fell.
The challenge of a rising interest rate differential in favour of U.S. interest rates is a challenge that will continue this week, into Q2, and over the next 18 months at least. The U.S. Fed has consistently telegraphed their aggressive pace of rate hikes. At EncoreFX we have also telegraphed the risk this poses to the kiwi dollar – and this last quarter you can see it taking effect.
Matters were made worse last week when RBNZ Governor Orr was perceived as dovish with his comments around the next move in NZ rates being equally balanced up or down. Technically, in the immediate future, Orr is correct. However, the RBNZ operates on forecast conditions an effort to pre-empt the economy. Realistically – the RBNZ Governor’s next move will be a rate hike.
Unfortunately for kiwi importers – perception is reality in FX markets, and the markets took Orr’s comments as dovish, sending the kiwi lower. If there is light at the end of this tunnel, it is two-fold. Firstly, that the lower kiwi dollar will raise inflation in NZ, faster than the central bank has previously anticipated. Secondly, that central banks around the world are targeting ‘normalisation’ of interest rates. It is probable in 18-months’ time that we will be talking about US interest rates nearing ‘normal’, with the threat of NZ interest rates about to start rising.
President Trump’s trade policies continue to stir unrest in global economies, and this is adding pressure to the kiwi. The U.S. is set to impose its tariffs on Chinese goods this week, with China poised to retaliate. So, who will win a trade war? If you ask any economist – the answer is typically ‘no one wins’. However, some have pointed out that China exports a lot more to the US than the US exports to China (about USD 480 billion vs USD 170 billion). So some might say the U.S. has the upper hand or “more to shoot at” as Trump puts it.
Regardless – the big question is where to next for these trade wars? And what impact for the kiwi? The current reality is that the uncertainty is hurting the kiwi, which is still a risk sensitive currency. Bloomberg summed up the mood on trade wars well here.
Last week we reported on tier 3 data (ANZ Business Confidence Survey) having a disproportionate effect on the kiwi. This week we have more business confidence data in the form of NZIER’s Survey of Business Opinion.
Business Confidence has taken a dive, and most people are blaming the government. After all, they do have a wide range of policies with uncertain outcomes for the labour market, housing market, immigration, taxation, and foreign investment. This has led business owners to downgrade their expectations, and this, in turn, will have an impact on the economy.
However, my take is this is not all is doom and gloom. Whilst there is some uncertainty – businesses are getting better and better and handling that uncertainty. ANZ’s survey can be found here, and whilst confidence is undeniably down, the business owners expectations for their own activity is still positive. The spotlight will be on this week’s business opinion data.
Australia has a busy week of data which could upset the apple cart. Tier one data includes Aussie Building Approvals, Retail Sales, and Trade Balance. However, the main event is Tuesday’s RBA Rate Decision. No change is expected, but markets will pore over every word looking for hints on the next move.
There is also plenty of data out of North America this week. We have ISM PMI Surveys (both Manufacturing and Non-Manufacturing), Factory Orders, and the all-important U.S. Non-Farm Payrolls report. The headline number of new jobs created is expected to come through at 195k. More emphasis will be placed on this employment data now that the U.S. Fed has erred towards two more rate hikes in 2018 rather than just one more as was the case a month ago.
The kiwi, for the first time in a long time, is now trading below fair value. The Q2 6.2% fall was overdue but unreasonably steep. Unfortunately for kiwi importers, foreign exchange markets had been sitting on all of the ingredients for a steep fall – and someone just needed to mix them together.
Overall – my view is that that the three key drivers are now well baked into current exchange rate levels. Interest rates have been well telegraphed, trade wars are coming into effect this week, and low levels of local business confidence are simply too harsh a perspective on reality. Therefore – the kiwi should find support around these levels, and I see 0.6800 – 0.7000 cents as fair value. Longer term I still continue with my low and slow bearish outlook.
There is always a but, and perhaps this is best summed up with this quote, credited to Keynes:
“The market can remain irrational longer than you can remain solvent.”
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