Roger J Kerr says the Aussie Government is decisive while our Government makes announcements about future announcements; an NZ win in the America's Cup won't necessarily spark a Kiwi dollar rally

Summary of key points: -

• Minor set-backs to stronger USD trend
• Commodity prices peaking-out?
• The “Gunna” Government and its policies
• Kiwi dollar correlation to America’s Cup Yachting victories and defeats

Minor set-backs to stronger USD trend

Daily swings up and down in the US 10-year Treasury Bond yield are continuing to have the dominant impact over the EUR/USD FX market movements, an in turn NZD/USD changes.

Earlier last week a slightly muted increase in US inflation in the month of February prompted the US long-term interest rates to pullback to 1.50%, reversing the EUR/USD rate from $1.1850 to near $1.2000 (lifting the Kiwi to 0.7240).

However, the central market thesis over recent months that US inflation is increasing and their economy rapidly recovering to a strong growth trajectory was soon back in play with higher wholesale prices (PPI Index) at week’s end.

The US bond market has sold off again with yields increasing to new highs of 1.62%.

The second set- back to a stronger US dollar (the first being in early February when weaker than expected jobs numbers weakened the USD) appears to have run its course. Many bond market analysts and commentators are predicting further 10-year Treasury Bond yield increases to 2.00% over coming weeks/months as fixed interest fund managers continue to shorten the duration on their investment portfolios i.e. they sell long-dated bonds and reinvest in cash or short-dated bonds to reduce their risk of marked-to-market revaluation losses as market yields increase (bonds go down in value).

Focus this week will be on the US Federal Reserve’s meeting on Thursday 18 March. Traders and investors expecting additional monetary stimulus will be disappointed.

The Fed will be happy the economy is improving (higher bond yields reflect that), the current stimulus levels are working and that the inflation increases are largely temporary. Further increases in bond yields and a stronger USD back below $1.1900 against the Euro seem likely, particularly if US retail sales, industrial production, real estate market and import prices data all are on the stronger side on Wednesday 17 March.

Local New Zealand data being released this week may add or detract to the general expectations outlined above of a stronger US dollar on global FX markets pulling the NZD/USD exchange rate lower.

The GDT dairy commodity auction on Wednesday morning will be watched with heightened interest following the 21% spike up in whole milk powder prices (“WMP”) to US$4,300/MT two weeks ago. If dairy prices sustain their sharply higher levels, it will be supportive of a higher NZ dollar value. However, if WMP prices sharply reverse at this auction to well below US$4,000/MT it will add to the expected lower NZD trend.

Likewise, the NZ GDP growth figures for the December 2020 quarter, although now historical, being released on Thursday. Consensus forecasts are for a 0.1% increase for the quarter, following the 14% rebound in GDP growth over the September quarter. Covid-related disruptions to the economy right through 2020 make such forecasts nothing more than a crap-shoot, however a media headline of a negative number would be viewed as negative for the Kiwi dollar.

Looking forward on the NZ economy over the first half of 2021, outside of buying and selling existing houses with each other (which adds nothing to the economy), all the measures of economic activity are looking to be quite sluggish. The consumer spending spree of last winter will not be repeated and export volumes are being dented by a shortage of labour to pick the crops.

Commodity prices peaking-out?

The future direction of the NZD/USD exchange rate over coming months will largely be dictated by AUD movements against the USD. In addition to expected general USD gains against all currencies, metal/mining commodity prices have the next largest influence over the Aussie dollar’s value. Soaring copper and iron ore prices over the last six months have justified the AUD/USD gains to 0.8000. However, the party may be ending for iron ore prices as inventory levels in China return to higher/normal levels, following the very low stock levels last October. In addition, the Tangshan region of steel mills in China is imposing environmental pollution controls which will reduce industrial production of the mills and coking plants. Iron ore prices have already reversed from above US$180/tonne to US$163/tonne and further profit-taking by commodity speculators will add to the new downward momentum.

The 'Gunna' Government and its policies

The contrast between the Australian and New Zealand governments in their handling of the post-Covid economic recovery could not be starker.

The Aussies are decisive and implement their plans. The current NZ Labour government makes announcements about making future announcements (the so-called housing market crisis being a recent example). It is easy to label them the “Gunna” government, they are going to (“gunna”) do this and they are going to do that, however they end up doing nothing!

Business folk have made a plea to the Government to share their post-Covid economic plans in a transparent way so that the business sector can offer their expertise to contribute to those plans. Nothing has resulted. The problem being that there is no plan to share.

The New Zealand economy has performed to a higher growth levels over the last 20 years following the bold economic reforms implemented by Sir Roger Douglas and Ruth Richardson in the late 1980’s and 1990’s. The NZ economy has benefited from the monetary policy and fiscal policy disciplines that these reformists established. They were all designed to make the NZ economy more globally competitive and improve living standards for our citizens. The Helen Clark and Sir John Key years in 2000’s and 2010’s were more status-quo, however none of the fundamental economic reforms were reversed.

The current Government has not advocated any bold economic policy changes, however a plethora of small policy changes at the edges is hobbling business (particularly agriculture) and adding costs, which in turn inhibits confidence, investment and output. More bureaucratic red tape regulation and cost from carbon, water, employment and transport policies all add up to making the NZ economy less globally competitive.

The previous superior NZ economic performance (aided by the 1980’s and 1990’s policy reforms) was an overall positive for the Kiwi dollar.

The current policy prescriptions add up to restricting opportunities to increase investment and output when price signals dictate that should happen and thus is marginally negative for the Kiwi dollar. Milk prices approaching $7.00/kg milk solids would normally see a switching of land-use to the higher returning dairy farming. Good luck on getting the consents to do that in the current policy environment!

Kiwi dollar correlation to America’s Cup yachting victories and defeats

Good old-fashioned Kiwi pride may drive you into believing that the economy and thus the NZD exchange rate always does well after we win the Rugby World Cup and the America’s Cup (“AC”) yachting regattas (punching above our weight in the global arena and attracting attention).

Unfortunately, the evidence suggests otherwise: -

• Only the late Sir Peter Blake’s and Sir Russell Coutts’ victory in San Diego in 1995 coincided with a rising Kiwi dollar value. The NZ economy was on a tear in the mid-1990’s after the commodity price recession in 1990-1992.
• The AC win back home in 2000 was right at the time of the Asian financial crisis and plummeting commodity prices/Kiwi dollar.
• We lost it to Alinghi in 2003, but the Kiwi dollar was doing the opposite due a strong NZ economy and weak USD at the time.
• The AC loss in 2007 in Valencia again to Alinghi was at a time when the RBNZ was tightening monetary policy by increasing interest rates to slow inflation coming from a housing market boom. The Kiwi dollar was skyrocketing as a result.
• At the time of the AC 2013 loss in San Francisco to Oracle Team USA, whole milk powder dairy prices were US$5,000/MT and the Kiwi dollar was trading above 0.8500 to the USD.
• Our stunning retribution victory on the foils in Bermuda in 2017 with Peter Burling and Blair Tuke coincided with a sideways NZD/USD pattern between 0.7000 and 0.7500.

The next few days will decide AC 2021. However, whichever way it goes, the Kiwi dollar will be doing its own independent thing!

*Roger J Kerr is Executive Chairman of Barrington Treasury Services NZ Limited. He has written commentaries on the NZ dollar since 1981.