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Interest Rate Market Commentaries - Weekly

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The Reserve Bank of New Zealand currently have a forecast that the annual inflation rate will reduce to 1.1% by March 2018 (currently the annual inflation rate is 2.2%). They also have a forward guidance to the market of no increase in the Official Cash Rate (OCR) until late 2019. The market for short-term interest rate in New Zealand is currently pricing in a 0.25% increase in the OCR in June/July 2018 and a 50% probability of another 0.25% increase by November 2018.

Both views cannot be right.

The question is whether upcoming economic data will force the RBNZ to change their view/forecast or will the data cause the markets to adjust their pricing downwards. Movements in oil prices have dominated inflation levels in New Zealand and around the global over recent years. The reduction in crude oil prices by some 22% (WTI crude falling from US$55 per barrel to US$43 per barrel) over this past month supports the RBNZ view on life. In their last Monetary Policy Statement the RBNZ were confident that the increases this year in food prices (fruit and vegetables) was purely temporary and would quickly reverse. The significant further increases in fruit and vegetable prices during the month of May due to adverse climatic conditions suggests that there is more of a permanent nature to the food price inflation. The debate continues on as to when and by how much wage increases will impact on inflation over the next 12 months after several years of very low wage increases.

The final piece of the inflation jigsaw is future movement of the NZ dollar exchange rate. The RBNZ are currently assuming a 76.00 Trade Weighted Index (TWI) through the next 12 months to produce a reduction in annual inflation to 1.1%. Currently the TWI is sitting at 78.50 and if it stays at this level the RBNZ may need to revise their inflation forecast even lower i.e. to a level less than the 1.00% target minimum. Fuel prices, in particular, will be moving lower with the current fall in oil prices and higher Kiwi dollar value. At 78.50 the TWI has monetary conditions too much on the tighter side given the RBNZ’s inflation outlook. Therefore, it was not surprising that the markets were expecting a more dovish RBNZ on the exchange rate last week than what was delivered on this front by Governor Wheeler. Maybe the references to the exchange rate by the RBNZ should have been more emphatic and assertive to influence it lower, as opposed to the sanguine FX reference which resulted in a higher Kiwi dollar value (the opposite to what the RBNZ would want to see).




NEW ZEALAND DOLLAR RATE MARKET COMMENTARY


Trade protectionism and political risk potential negatives for the Kiwi dollar

The NZ dollar has consolidated its gains against the USD in the 0.7200 to 0.7300 trading range over the last two weeks. There has not been any sufficiently negative news to deter the buyers and holders of Kiwi dollars. Whilst the GDP growth outcome for the March quarter at +0.50% was less than consensus and RBNZ forecasts, the forward outlook for economic expansion remains extremely positive with both consumer and business confidence surveys returning to high levels. Confidence and optimism stemming from the ingenuity, inventiveness and true sporting grit displayed by our Kiwi yacht race guys in the America’s Cup can only boost that positive economic momentum. A nation’s currency value can be likened to a share price on its economy and right now with the New Zealand economy performing so well it is difficult to see what would cause a sustainable depreciation of the NZ dollar. However, foreign exchange markets are always looking six to 12 months forward as to the likely future economic conditions and performance. Therefore, historical GDP and other economic measures may not be reliable indicators as to future NZD/USD direction as future expected conditions may not be the same as the past.

It also must be remembered the New Zealand’s economic health and direction is only one side of the two sided equation that makes up the NZD/USD exchange rate. How the US dollar itself is moving in global forex markets against all currencies determines the NZD/USD direction as well. Right now the USD is marooned at $1.1200 against the Euro with the international financial and investment markets remaining very unsure as to whether the Federal Reserve (projecting four 0.25% interest rate increases over the next 12 months) will be correct, or will the US short-term interest rate markets be correct with their forward pricing (projecting just one 0.25% interest rate increase). Much depends on the trend of US inflation from here. If the US’s inflation and economic data supports the Fed’s outlook over coming weeks/months, then the US dollar should recover and appreciate back to below $1.10000 against the Euro. A stronger USD on the world stage will pull the NZD/USD back towards 0.7000.

Over coming months two potential risks that may prove to be negative for the Kiwi dollar in its own right will come into the focus of the FX markets:-

• Three months ago the Trump administration announced a three month study/investigation as to what imported products into the US from what countries were replacing US manufacturing jobs. The results of that investigation are due very soon and it is likely that new US import tariffs and trade protectionism will be the recommended solution. If the new trade barriers extend to agriculture products, then the NZ dollar will be sold down by the markets, just as it was in early May when President Trump tweeted that dairy products could be added to tariffs imposed on Canadian lumber coming across the border into the US.

• Political risks on the NZ economy and NZ dollar exchange rate are set to increase over the next three months in the run up to the late September General Election. From an offshore investor and currency speculator’s perspective the prospect of a potential change of Government to a more left-leaning Labour/Greens coalition would appear very strange to them given how well the economy is travelling. The NZ voting public rejecting the economic and employment growth for some other objectives would cause those overseas investors into NZ shares and bonds to reduce their holdings (thus become sellers of the NZ dollar in doing so). It does appear that the election campaign will be fought over immigration, housing and environmental issues (not financial/economic issues), therefore the incumbent National Government faces a real challenge to be re-elected for a record fourth term. Typically, political risk in New Zealand is not rated by overseas players as that influential for the currency. However, the prospect of a hung Parliament with NZ First’s leader Winston Peters calling the shots as to whom he will support to form a new Government would have to be unsettling for any foreign investor in the Kiwi dollar.
Political opinion polls will be as important as inflation, GDP growth and export commodity prices as a lead indicator and direction driver for the Kiwi dollar over the coming period.