Roger J Kerr sees a favourable case for further appreciation of the NZ dollar to the mid-0.6000s over coming months on the back of lower US interest rates (weaker USD) and higher Australian interest rates (stronger AUD)

Summary of key points: -

• US economy starts to falter
• UK economy starts to bounce back
• Crunch time looming for the Reserve Bank of Australia

US economy starts to falter

US economic data has certainly taken on a softer tone over recent weeks, not allowing the US dollar exchange rate to appreciate any further against the major currencies. The USD Dixy Index has remained within a 104.77 to 105.60 trading range, ending the week at 105.17. The NZD/USD rate has remained above the key 0.6000 big figure level in quiet market trading conditions.

Following the much weaker than anticipated US employment and ISM Services PMI data for April on Friday 3rd May, the weaker economic trend was supported over the course of this past week by jobless claims (numbers signing on for the unemployment benefit) being higher at 231,000 compared to consensus forecast of 210,000 and the Michigan Consumer Sentiment Index dropping sharply to 67.4, compared to prior expectations of stability at 76.0. The financial markets focused on the inflation expectations segment of the Michigan consumer survey which increased from 3.20% to 3.50%. However, it would be inadvisable to read too much into that higher result as those surveyed always see future inflation as whatever the current historical/actual inflation rate is. US annual inflation did lift marginally in January, February, and March, however as we have evidenced previously, that is the case every year and typically price increases are significantly less over the balance of the year. There is no doubt that the recent fall in household/consumer confidence in the US is related to higher mortgage interest rates over recent months, higher auto loan/lease costs and the labour market turning decidedly softer.

The slew of weaker economic data over this last month does start to confirm that the higher inflation and jobs numbers in the first quarter, that scared the horses in the bond and FX markets, were something of an anomaly (due to dodgy jobs data and elevated inflation due the American companies only increasing their prices annually in January and February). The annualised GDP growth in the March quarter at 1.60% was much lower than forecasts, which starts to prove that many economic forecasters have been far too optimistic on their outlook for the underlying performance of the US economy.

Coming up this week is the US CPI inflation figures for the month of April on Wednesday 15th May, an increase of 0.30% is expected, which will increase the annual rate from 3.40% to 3.50%. As always, a lower result will send the US dollar value and US interest rates lower (and vice-versa). The wholesale prices, PPI Index, the day before on Tuesday 14th May could well surprise with a lower reading than the +0.20% anticipated (annual rate of 2.40%). Crude oil prices reduced 9.20% from US$87.40/barrel to US$79.40/barrel over the month of April. Retail sales for April (released 15th May also) are expected to be a lower 0.40% for April compared to the robust +0.70% in March. Industrial production in the US economy for April is also expected to be a very flat outcome when released on Thursday 16th.

For many months now the US dollar bulls (those punters/traders expecting continuing USD appreciation) have cited superior US economic performance over other economies as a reason for their stance and positioning. As the evidence mounts that economic recovery is improving in the UK and Europe and the numbers slide lower in the US economy, that justification for holding US dollars in preference to other currencies will also slide away. Already, we are witnessing the increase in the price of gold over the last 12 months being attributable to central banks favouring buying gold for their reserve assets over buying US dollar denominated securities at a high USD value against their home currencies.

If the weaker US economic data does not convince you that the US dollar will weaken on lower US interest rates, perhaps the spectre of a newly elected Donald Trump as President in November, slashing income tax rates for the wealthy, which in turn sends the already catastrophic US Federal Government annual budget deficit to a even larger deficit, will be the nail in the coffin for the US dollar. In addition, do not think for a moment that Fed Chair Jerome Powell will not cut interest rates ahead of the November US Presidential election. The Fed is staunchly independent of meddling politicians and will act in the best interests of the US economy to achieve their dual mandate of 2.00% inflation and a stable/low unemployment rate. Another one or two months of soft Non-Farm Payrolls employment outcomes will see the Fed cutting interest rates sooner rather than later to meet the employment objective, irrespective of whether annual core inflation is 2.00% or not.

UK economy starts to bounce back

The UK economy has been viewed by most over recent years as a depressed basket-case, ravaged by Brexit and Covid. However, the previous contraction in economic activity has reversed with confirmation this last week that their GDP growth increased by 0.60% for the March quarter, well above prior consensus forecasts of +0.40% and a dramatic turnaround from the -0.30% contraction in the December quarter. UK manufacturing is resurging again, finding new markets for their products post exiting from the EU. The Bank of England held their official interest rates at 5.25% during the week, however market expectations are that they will commence cutting interest rates before the end of the year. Two-thirds of the UK’s annual 3.20% inflation rate currently is related to hospitality and alcohol prices, reflecting stronger consumer demand and a shortage of staff to serve in the over-crowded pubs and restaurants.

The next UK inflation figures for April are due out on 22 May and a low result will assist an earlier cutting of interest rates, which will further aid growth in their economy. The UK Government is signing up to new foreign trade deals and the immediate negative impact of Brexit is starting to wane. The UK economy is performing again despite a woeful and splintered Tory Government. The next UK general election must be held before 28th January 2025; however, it is widely expected that PM Rishi Sunak will call the election before the end of this year. Several commentators are suggesting that a Keir Starmer-led Labour Government would be more stable, fiscally prudent and better for the stock market and the Pound currency value than the bumbling Conservative Government.

The US economy, the UK share market and the UK Pound Sterling exchange rate all must be viewed as currently undervalued after years of neglect, therefore ripe for early moving investors seeking an alternative to the faltering US economy. 

Crunch time looming for the Reserve Bank of Australia

Australian economic data due for release this week could make or break the Reserve Bank of Australia’s (“RBA”) so called “current neutral stance” on monetary policy and interest rate settings. The chorus of opposition against the RBA’s decision last week to hold their interest rates at 4.35%, despite increasing their 2024/2025 inflation forecast, is steadily growing. Wages and employment data this week, if stronger than forecast, will further increase the calls for the RBA to increase their interest rates at their next meeting in early June. The wage price index for the March quarter being released on Wednesday 15th May is forecast to increase by 0.90%, leaving the annual wage increase at 4.20%. Employment growth a day later Thursday 16th May is expected to be +25,000, an actual figure well above that will send market interest rates higher and the AUD upwards.

It was reported by RBA Governor Michele Bullock that the RBA Board did discuss a possibility of an interest rate increase at their meeting last week, however in the end they opted to hold off from such a decision that would have them completely at odds with every other central bank in the world who are now seeking to reduce interest rates. The Swedish Riksbank cut their interest rates last week. In the end, the Aussies will be forced to increase their interest rates by the strength of wages and inflation data. The RBA monetary policy error of thinking that 4.35% interest rates would do the job to bring inflation down is now being cruelly exposed.

Adding to the RBA’s embarrassment on poor inflation control is the fact that they have still yet to formalise their independent monetary policy/interest rate setting committee from the RBA reform report tabled last year. The politicians are arguing over who will sit on the committee.

An interest rate hike in Australia this late in the inflation/economic cycle would certainly send the Aussie dollar sharply higher, which the NZD/USD rate would invariably follow. Also supporting the view of a stronger AUD against the USD from current levels of 0.6605 is continually improving Chinese economic data. Last week Chinese import/export data, vehicle sales and inflation were all stronger than expected. The Chinese economy is not yet back at the full noise of pre-Covid; however, it continues to improve and is certainly a lot healthier than 12 months ago. Stronger Chinese economic data is always positive news for the Aussie dollar value.

What does it all mean for the NZD/USD exchange rate?

Bringing the strands of argument in this commentary together combines to make a favourable case for further appreciation of the NZ dollar to the mid-0.6000’s over coming months on the back of lower US interest rates (weaker USD) and higher Australian interest rates (stronger AUD). As the chart below shows, a move above 0.6700 in the AUD/USD exchange rate breaks the three-year downtrend line.

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