How the New Zealand economy performs in terms of GDP growth over the next 12 months will determine inflation risks and that in turn determines monetary policy settings i.e. the level of short term interest rates. Right now with the NZD/USD exchange rate above 0.8000, 2012 GDP growth forecasts have to be nearer +1% than the previous +4.5% forecasts.
As the RBNZ economists contemplate the massive changes in the global economic and financial market landscape and conditions since their June monetary policy statement, you can bet the September MPS (released 15 September) will be a lot different in tone and outlook than the positive June statement. Even though business/consumer confidence and other domestic economic indicators have not changed much over the past two months, there have been significant changes in the engine room of the NZ economy, the export sector.
Exchange rate volatility and sharp downturns in some export commodity prices have fundamentally slashed the positive growth outlook of just a few short weeks ago to something today that is much more uncertain. Revisions down in global growth forecasts will be a feature of the RBNZ MPS analysis and will support their decision to leave OCR increases on hold until at least December. The previous rosy export outlook now has severe risks around it if the NZ dollar does not depreciate over coming months. Local economic commentators do not appear to have understood the significance of the recent falls in wholemilk powder and forestry prices.
The commodity boom the NZ economy has been enjoying may have run its course and a revision downwards in Fonterra’s $7.25/kg milksolids payout at some stage over coming weeks has to be on the cards. A lower dairy industry payout number would certainly have negative connotations for the economy as a whole. At the start of the year the RBNZ released a research paper confidently predicting that our high agricultural export commodity prices were here to stay for the long term. Current price trends downwards are now seriously threatening that underlying economic assumption. Up until three months ago the commodity price increases were matching the NZD appreciation.
The events since have seen commodity prices fall and the NZD spiral upwards to 30-year highs of 0.8840. The economic equation has shifted and only a currency fall unrelated to commodity price decreases looks likely to prevent the economy from pathetic growth rates next year. The inflation risks have reduced as a consequence, so the RBNZ will be justified in delivering a much more dovish statement come 15 September. Interest rates are lower for longer unless the currency value decreases to the low 0.7000’s.
NEW ZEALAND DOLLAR MARKET COMMENTARY
Aussie dollar glory days fading fast
Nearly all the forwards indicator drivers of the NZD/USD exchange rate value currently point to the Kiwi being nearer to 0.7000 than the current 0.8180 exchange rate value. An observation of historical correlations and linkages of the NZ dollar rate to the EUR/USD rate, CRB Index, Wholemilk Powder prices, VIX sharemarket volatility Index, Dow Jones Index, the 2-year NZ:US interest rate swap differential, US ISM Index and Chinese PMI Index all suggest a much lower NZD/USD rate. Three plausible and standout reasons why the NZ dollar has not depreciated to the low 0.7000’s, as these indicators suggest, are as follows:-
§ Over and above all the aforementioned drivers, the dominating NZD/USD determinant is the AUD/USD exchange rate. The very stable NZD/AUD cross-rate through all the wild currency market volatility of recent weeks just tells you how much the Kiwi is closely tracking AUD movements against the USD. The AUD appreciation in 2010 and early 2011 on higher commodity prices and higher interest rates outweighed the other drivers.
§ Relatively speaking, on one particular economic fundamental ratio of Government debt to GDP, New Zealand looks very good against most other countries that are plainly awful at this time. However, international fund managers and their economists rating NZ up there on this metric seem to be foolishly ignoring our very high household debt ratio to GDP.
§ The global funds parked temporarily in New Zealand dollars ahead of the US debt ceiling ultimatum date of 2 August may not have fully reversed out again. The dramatic pull-back in the NZD from highs of 0.8840 to 0.8000 over recent weeks indicates that most of the money has flown back out, however perhaps not all.
The rise in the NZD/AUD cross rate from 0.7500 to above 0.8000 two months ago was based on the prospect of NZ interest rates increasing from September and the NZ/Australian interest rate differential closing up. The situation has now changed with the high NZD forcing the RBNZ to have a much more downbeat Monetary Policy Statement in September than the upbeat prognosis they delivered back in June. New Zealand interest rates will be lower for longer and thus the NZD has already started to pull back below 0.8000 against the AUD. However, the AUD/USD direction over coming months will remain as the dominant driver of the NZ dollar direction.
An analysis of current developments in Australia leads to a conclusion that the luck may have run out for the lucky country and its currency. Australia sailed through the GFC without a domestic economic recession, without a property market downturn and the mining resources sector boomed away on strong Chinese demand. Australia therefore never made any business and economic adjustment to the new world order, which may be catching up with them now.
Recent Australian domestic economic data has all been very weak in the retail, manufacturing, housing and employment areas. Non-resource sector exporters have been pounded by the high Australian dollar. Retailers cannot compete against cheaper prices for stuff purchased in USD online. Local manufacturers are losing money and market share to cheaper imports. The high Aussie dollar and their higher mortgage interest rates over the past 12 months has created the two-speed economy with NSW and Victoria states hit hard compared to the mining states of WA and Queensland.
BlueScope Steel is downsizing its Port Kembla steel mill with a thousand jobs lost as they cannot operate profitably with the high AUD and high coking coal input prices. OneSteel axed 400 steelmaking jobs last week in Australia. Another iconic Australian company, Qantas appears to be in disarray as they battle with union-controlled, over-priced pilots and staff in Australia. All is not well across the ditch!
Lower global GDP growth forecasts over recent weeks have forced hard commodity prices downwards, potentially threatening the one area of positive economic activity that has been holding the Australian economy together. As a result of these economic shifts, Australian interest rate markets have completed an incredible U-turn since May. They are now pricing-in 1.00% reductions in official interest rates over the next 12 months, a sharp reversal from the forward pricing that had increases built in only three months ago. The sudden decreases in Australian swap interest rates have removed one of the positive supports for the AUD. The interest rate gap points to the AUD/USD exchange rate falling away from its current $1.040 level to well below $1.0000 over coming weeks/months. Where the Aussie dollar goes, we follow.
An RBA testimony speech by Governor Glenn Stevens this Friday, coupled with preliminary Chinese PMI data this week may be catalysts for the AUD currency market to turn much more bearish in the same way their interest rate markets have turned in recent weeks.