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Interest Rate Market Commentaries - Weekly

03

It started with the plummet in the market price of the cryptocurrency, Bitcoin two weeks ago and now the “risk-off” sentiment of investors has spread into the US sharemarket. The 600-point downward correction in the Dow Jones Index last Friday 2nd February is perhaps the first sign that investment markets are finally reacting to the increase in interest rates now being witnessed in the US. Long-term 10-year US Treasury Bond yields have ramped higher to 2.84% over recent weeks and strong US economic data certainly backs the Federal Reserve’s intentions to increase their short-term interest rates another three times 0.25% this year. US wage increases now occurring supports the Fed’s view that inflation will move above their 2.00% target this year. Through the December/January period, the US dollar depreciated from $1.1800 to $1.2500 against the Euro as FX markets discounted in advance the ending of European easy monetary policy and the Euro was favoured over the US dollar. That currency tide may be about to turn as both US short-term and long-term interest rates continue to increase right now and the cash yield advantage of holding US dollars over Euro’s increases. In other words, the cost of borrowing USD to invest in EUR at 0% interest rate return does make it expensive to hold long Euro/short USD currency positions. A pull back in the EUR/USD exchange rate to $1.2000 therefore appears more likely over coming weeks than continued USD selling, as market positions are unwound. 

The NZD/USD exchange rate zoomed up from 0.6900 to 0.7400 over the December/January period predominantly due to the general US dollar weakness against all currencies. Having climbed to above 0.7400 on numerous occasions over recent weeks, the Kiwi dollar has once again retreated from that resistance level to trade lower at 0.7300. The failure of the NZ dollar to hold onto gains above 0.7400 tells us that the currency speculators who play in the Kiwi are nervous about holding the currency when the “risk-on” investor sentiment that drove it upwards is starting to wane. Commodity currencies such as the Kiwi dollar tend to appreciate when equity market indices and commodity prices are rising on a stronger global growth story. However, when US sharemarkets are heading downwards in a major corrective manner, the NZ dollar will usually follow. The signs of investor confidence in commodities was reducing emerged two weeks ago when iron ore prices started to reverse down from their strong gains through December and early January. The Australian dollar tracks iron ore prices closely and it is not surprising that the AUD/USD exchange rate has reversed sharply lower from highs of 0.8067 last week to 0.7920 today. The NZD/USD rate has outperformed the AUD/USD rate over this last week, not falling as much against the USD, resulting in the NZD/AUD cross-rate jumping up from 0.9050 to 0.9200. At a current rate of 0.7300, the NZD/USD rate may still have some catching up to do on the lower AUD/USD rate and thus further selling into the 0.7200’s and lower looks likely in the short term.

The local NZ economic and investment factors that influence the Kiwi dollar’s value continue to be a mixed bag. Business confidence has not recovered too much from the plunge lower in November and December due to uncertainties around the economic policies of the new Labour Coalition government. However, consumer confidence has picked up in January and the property market is showing signs of reinvigoration after all the uncertainty over recent months. The New Zealand economy is still performing well overall with the main risks still pivoting on export commodity prices easing back down from their historically high levels. 

One risk the NZ dollar does face going forward is the fact that our long-term interest rates are no longer sufficiently attractive as an alternative higher-yielding investment to US Treasury Bond yields. Our 10-year Government Bond yields currently at 2.98% are only 0.15% above US Treasury Bond yields at 2.84%. Foreign holders and investors into our NZ bonds will not see why they should take the currency risk on a small illiquid market with a narrow based economy for only a 15 basis points yield advantage. Historically, the spread or margin between NZ and US bonds has been above 1.00% to compensate the foreign investors for the additional risk. The decrease in New Zealand’s risk premium does not seem sustainable and should lead to foreign investors reducing their holdings of NZ bonds. They will be selling the Kiwi dollar as they exit the bonds. 

The Reserve Bank of New Zealand’s Monetary Policy Statement this week should not rock the NZ dollar currency boat as they stick to their current forecast of not lifting the OCR until mid-2019. The global GDP growth picture in early 2018 is more positive for the NZ economy than previously. However, the RBNZ will see heightened risks of international financial and investment market volatility increasing as markets correct downwards from some spectacular increases. Increased market volatility is typically negative for the Kiwi dollar.