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Interest Rate Market Commentaries - Weekly

The first law of economics is that changes in both demand and supply cause a change in the price of the good or service. The lack of wages growth in both the US and NZ economies over recent years despite the two strong labour markets (low unemployment rates) raises the issue as to whether something else is happening that we do not know about.

The conventional economic models are based on the premise of:-

Strong GDP growth = strong labour market = rising wages = rising inflation = higher interest rates as monetary policy is tightened in response.

My argument would be that increasing wages and inflation in both the US and New Zealand are currently merely delayed, not permanently obliterated.

Whilst high levels of inwards immigration and Kiwis not leaving home has increased the New Zealand labour supply and thus subdued wages increases to date, in the US that has not been the case. Like everything to do with how economies tick, the devil is in the detail. The growing industry sectors in the US economy are health, education and business services

The US Federal Reserve continues to expect US inflation to be pushed higher from the strong labour market and thus wage increases. The US interest rate markets currently reject the Fed’s view and their pricing of future interest rate changes indicates that they do not believe wages and inflation will increase.

Both cannot be right, however I would back the Fed’s analysis and therefore we must expect material increases in both US short-term and long-term interest rates over coming months/years.


Likely profit-taking by speculators makes the Kiwi dollar vulnerable

Whilst the Kiwi dollar has remained at the top end of its trading range against the US dollar above 0.7300, its overall performance in the forex markets has been one of hesitancy as the currency has not made gains against a weaker USD as the other major currencies have over this last week. It seems that the FX speculative fraternity are somewhat reluctant to buy the Kiwi aggressively at these levels which are at the top end of its 12 month trading range. The market’s hesitancy around pushing the NZD/USD rate higher could also be associated with the two risks that are coming up, which we highlighted last week i.e. The US trade/import tariff report which is now due and the NZ General Election in late September.

The spectacular five cent ramp up in the NZ dollar from lows of 0.6820 in mid-May to above 0.7300 today was mostly due to speculators reversing positions from being short-sold NZ dollars to going “long” on the Kiwi. The chart below confirms the reversal in position taking through the month of June as outstanding NZD/USD futures contracts on the Chicago Exchange dramatically changed from 15,000 net short NZD positions to 20,000 net long NZD positions today. The long position holders are now sitting of profitable trades as the Kiwi soared up to 0.7300.

History tells us when the long NZD futures contracts move above 20,000 in number the Kiwi dollar becomes extremely vulnerable to a sell-off as profit-taking by those position holders requires the Kiwi to be sold. The NZD/USD exchange rate reversed engines from highs in 2011, 2012, 2013 and 2014 when the open futures contracts were over 20,000 long NZD. We are back there again and the risk/reward equation suggests profit-taking from the speculators will once again send the Kiwi dollar lower over coming weeks/months. As always, it will require a catalyst to prompt the punters to sell the Kiwi. That catalyst may well be the Trump trade/import tariff report that is due out any day now. We observed a two cent sell-off in the NZD/USD rate in late April when President Trump tweeted that imported dairy products could be added to the Canadian lumber import tariffs.

A very similar scenario is brewing again right now and thus local USD importers should be hedged to high levels over the next six months and exporters holding off or using FX options as the method of hedging.