By Gareth Vaughan
Here's our monthly currencies outlook and review with HiFX's senior dealer Dan Bell, including a look at what a growing interest rate differential between New Zealand and the United States and Japan might mean.
Bell says the US non-farm payrolls report, out over the weekend, leaves the path clear for the US Federal Reserve to continue tapering off its monthly bond buying, or quantitative easing, programme.
The non-farm payrolls report showed US payrolls - excluding government agencies - rose by 192,000 in March, a bit lower than the 200,000 expected by analysts polled by Bloomberg. The unemployment rate was unchanged at 6.7%. However, the participation rate, indicating the share of working-age people in the labour force, rose to 63.2% from 63% in February.
What's the 'new normal' for US interest rates going to look like?
The Fed has so far scaled back its monthly bond buying by US$30 billion, but is still effectively printing US$55 billion per month.
"I think they've got a clear path set there for tapering. At the end of the day they are still printing $55 billion a month so there is still a lot of stimulus being thrown at the US economy," says Bell.
"The US economy is improving, they will continue to remove the stimulus. But they're not going to be raising interest rates any time soon. I think the earliest expectation is around April-May next year. So whilst they are removing the stimulus, their short-term interest rates are still basically zero bound at 0% to 0.25%," Bell says.
Analysts and policymakers are now talking about what the new normal for the US economy and US interest rates might look like.
"With interest rates there at effectively zero at the moment, some are saying the new normal in the US might only be a Fed Funds Rate, which is similar to our Official Cash Rate, of 1%, 1.25%, 1.5%."
"You look at that from little old New Zealand where our cash rate's already at 2.75% and our Reserve Bank is talking about potentially taking the cash rate up to 5%, and you compare that with the US and that's a huge spread in differential between us and the US economy," Bell points out. "Obviously that's going to continue to provide support to the New Zealand dollar."
Having traded as high as US87 cents during March, the Kiwi was at US86c on Monday. The Kiwi's post float high against the greenback, as measured by the Reserve Bank, is US88.22c on August 1, 2011.
As noted by PwC's Roger J Kerr, the recent fall in milk powder prices has so far not weakened the Kiwi dollar.
"If this trajectory of interest rate expectations continues, the spread between New Zealand and US interest rates in due course, within the next 12 months or so, is actually going to be worse than what it is now," says Bell. "So where does that take the New Zealand dollar? Does that mean our new normal for the currency is US80c to US90c, or even potentially higher?"
"I don't know. but the Reserve Bank has recently made some comments about the currency and ultimately that exporters are getting more used to it and that it is becoming more of a fact of life.
And I think to a certain extent, they're quite right there. You're not seeing as much push back from the exporter community around the high currency, and obviously the commodity guys are doing well. But at some time it will start to have a pretty big impact on our economy."
The Reserve Bank next reviews the OCR on April 24, and is expected to increase it by 25 basis points to 3%.
"And the market thinks we'll see interest rates up another 50 basis points to 75 basis points in the second half of this year as well. That has been clearly signalled by the RBNZ."
"How much of that is priced into the New Zealand dollar already, quite a bit. I think your wholesale market participants have already positioned expecting the New Zealand dollar to be strong this year, and it's already reflected in the fact the TWI (Trade Weighted Index) has hit all time highs. The New Zealand dollar against the Japanese yen hit almost 90 the other day, (it's) very strong against the yen, the euro, the pound, everything. It's holding up very, very well," Bell says.
"So whether or not we're going to see new demand come into the New Zealand dollar when we actually see those interest rate hikes, is going to be quite interesting in the second half of the year."
'The carry trade is still relevant'
If there is growing demand for the New Zealand dollar as the year unfolds it could be driven by Japan and the carry trade, through which investors borrow in currencies with lower interest rates and use the proceeds to invest in economies with higher yields.
The Bank of Japan's Overnight Call Rate is stuck at 0.1% and it's undertaking its own form of quantitative easing, which according to Bloomberg, is expected to see currency in circulation boosted by more than 50% by the end of 2015.
"So I think the carry trade is still relevant."
Although a lot of carry trade investors got "cleaned out" during the global financial crisis (GFC) things are now on a more stable footing. Prior to the GFC Uridashi bonds, denominated in the New Zealand dollar and sold directly to Japanese household investors, were popular.
"The overall outlook for the global economy is pretty positive. And in that sort of environment when you're not getting paid anything on your money, in fact you're taking a loss after you account for inflation, investors are going to stretch themselves a little bit and the Kiwi looks quite attractive," Bell adds.
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Dan Bell is the Senior Dealer at HiFX, a UK-headquartered foreign exchange dealer with significant operations in Australia and New Zealand. It has a dealing room in Auckland. See more detail here.
2 Comments
The carry trade I'm sure is still relevant, but is it useful to New Zealand? In a scenario where monetary policy settings would be best for the NZD to be x% lower than it is, what use is the carry trade? Are there ways for the Reserve Bank to either counter the appreciation, or take advantage of the over valuation?
It still strikes me that when the currency is overvalued, the RB could/should act counter cyclically by either buying foreign securities, or funding Treasury spend directly, instead of acting pro cyclically by borrowing or selling assets offshore.
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