- Local economic data continues to be irrelevant for the Kiwi dollar’s direction
- Current largest contributor to US inflation about to reverse?
Local economic data continues to be irrelevant for the Kiwi dollar’s direction
Last week, the better than generally expected NZ GDP growth number for the June quarter of +1.70% very briefly stirred the NZD/USD exchange rate 20 pips higher, however it was very soon pushed below 0.6000 by yet another surge in the US dollar value.
The week before, dairy prices increased for the first time in four months, in years gone by that would have resulted in a higher Kiwi dollar as FX traders viewed dairy commodity prices as a proxy for the NZ economy. The Kiwi dollar found no buying support from the dairy lift as the offshore FX traders have for more than two years now dismissed the NZ currency as a trading opportunity. The evening up of international interest rates at 0% through the Covid pandemic period and now as they are all around 3.00% (except Europe and China), the Kiwi dollar offers no advantage, interest or opportunity for the currency punters. The GDT dairy auction this Wednesday morning will most likely see a continuation of price increases as European supply to export markets dwindles (due to their energy crisis), however do not expect NZD gains as a result.
Given the clear evidence that New Zealand economic news releases and trends are having absolutely no impact on the NZD/USD exchange rate (and have not for two years now), it is somewhat surprising and very odd that the regular local bank FX reports only ever cover NZ factors in their NZ dollar commentary section.
The outlook for the NZ economy is subdued at best, given chronic labour shortages, higher mortgage interest rates, low business investment and low business/consumer confidence levels. However, that does not mean that the NZD dollar cannot recover form 0.6000 and move substantially higher when the US dollar turns around on the global stage. Credit rating agency, Standard & Poor’s delivered a reasonably positive report card on the NZ economy last week. They said our economy performed better than others through the Covid shock. A cynical response to the S& P report is that they only spoke to Treasury and RBNZ mandarins in Wellington, business folk in the regions would have given them a different message!
US dollar gains against the EUR and AUD caused another flirtation below 0.6000 to 0.5945 for the NZD/USD rate last Friday, however it has again recovered back to 0.6000. Ahead of the Fed meeting this week, the FX markets will be eying up US housing data with the NAHB Index for September on Tuesday morning and August housing permits/starts on Wednesday morning. The NAHB Index is forecast to reduce further from 49 to 47. Weaker housing figures in the US will not be positive for the USD as the following analysis addresses.
Current largest contributor to US inflation about to reverse?
On Thursday morning (6am) this week we hear form the US Federal Reserve with a 0.75% increase in their official interest rate, “dot-plot” 2023 interest rate forecasts from the individual voting Fed Governors and updated economic forecasts. They will predictably tell the markets and the world that US interest rates have to be maintained higher for longer to bring down the high inflation. All that hawkish rhetoric is already fully priced-in to bond, equity and FX markets.
The following series of four charts suggest that the rapid tightening of US monetary policy over recent months has already smashed the US housing market and it is only a matter of time (within the next three or four months) before the consequences of their actions will force the annual inflation rate to move sharply lower. The bond, equities and FX markets must soon start to anticipate the analysis below and price-in the Fed nearing the end of their tightening cycle i.e the job they needed to do is done!
Chart 1: The rapid increase in US home mortgage interest rates from 3.00% to over 6.00% over the last six months (red line, right-hand inverted axis), has sent confidence in the house construction sector (NAHB Index blue line, left-hand axis) plummeting, with further decreases highly likely. The tighter monetary policy from the Fed is already having a massive negative impact on housing.
Chart 2: Historical corelations inform us that US house building permits (red line) and housing starts (green line) will follow the NAHB Index (blue line) sharply lower over coming months.
Chart 3: The dramatic increase in US house prices (due to excessive Covid-related loose monetary policy in 2020 and 2021) has started to turn down. The Case Shiller House Price Index (blue line) appears to have peaked and has started to turn lower. The historical correlation of house prices to the NAHB Index suggests that house price increases will quickly reduce to 0% from the current +18% (yellow arrow down).
Chart 4: Historical correlations and “cause and effect” also tells us that falling US price prices inevitably leads to decreases in house rents (US Sheter CPI, red line, right-hand axis). What we do not know with precision is the time-lag between decreasing house price and falling rents. The Federal Reserve must know the expected lag and for that reason they should be anticipating that the current rising house rents (the current largest contributor to US core inflation) are unsustainable and when they just level off, the annual inflation rate will reduce as fast as it went up from 3.0% to 8.5% over the first half of 2022. The Fed need to look out the front window of the car, not the rear-vision mirror of economic data.
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*Roger J Kerr is Executive Chairman of Barrington Treasury Services NZ Limited. He has written commentaries on the NZ dollar since 1981.
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