Whilst GDP growth in the September and December quarters will be distorted by the Canterbury earthquake, the rebound in growth through the first half of 2011 may well surprise on the upside. The problem is that we will not know officially how the economy performed in the first three months of 2011 until late June 2011. The three-month lag in counting what has happened in the economy by Statistics NZ is quite unacceptable, and I am sure it is frustrating for the RBNZ as it is for everyone else. It pays not to mention the HLFS unemployment/employment statistics as the survey sampling is a complete mess and the numbers are not to be relied on.

 

My view is that the FX and interest rate markets will start to reflect GDP growth being higher in 2011 than generally forecast well before the official figures in June 2011. The moneymarkets should start to price the potential of much more rapid increases in the OCR from March 2011 when it is realised that GDP growth in 2011 will be well above the RBNZ’s +2.6%. By December this year I see the market sentiment and direction turning to such pricing due to the following developments:-

 

1.      Domestic retail and housing market confidence and sentiment improving as the GST/income tax cut changes are now known and employment uncertainties reduce.

 

2.      Business and consumer confidence improving as Jo and Josephine Public realise that the economy is expanding on good export performance and the prospect of a double-dip recession was just scaremongering.

 

3.      The massive household de-leveraging and economic re-balancing running its course and wallets opening up somewhat.

 

4.      High export commodity prices holding up and thus delivering higher profits and incomes in rural NZ.

 

5.      Manufacturing improving markedly from current levels as the 0.7600 NZD/AUD cross-rate makes selling into Australia very profitable indeed. Output, investment and jobs can be expected to increase in this sector.

 

6.      The 2011 Rugby World Cup providing a boost to tourism and the Christchurch re-build providing a real boost to the construction sector.

 

The major proviso to this more bullish economic outlook is that the NZD/USD exchange rate does not stay above 0.7500 for a prolonged period and ruin the advantage of the high commodity prices and hamper the export-led recovery.

 

The net result of improving domestic conditions is that the RBNZ will be forced to hastily revise their GDP growth forecast back up again in early 2011. Their remit is to manage monetary policy today on their forecast of the economy and inflation risks in 12 to 18 months time. My take on matters is that they will be forced to remove the “emergency monetary stimulus” much earlier than the picture painted in their September Monetary Policy Statement.

 

  

 

 

Whether the NZD/USD exchange rate remains above 0.7400 for a prolonged period or not really comes down to how global forex markets react to two key upcoming events:-

 

1.      The G20 summit meeting in Korea on 11 November and the likely reduction in tension between the US and China on the Yuan’s currency value ahead of and during that meeting. The USD itself should recover recent losses in global FX markets if the prospect of US trade protectionism against China decreases.

 

2.      The US Federal Reserve meeting on 3 November wherein Ben Bernanke will deliver the second phase of quantitative monetary easing (“QE 2”), however the amount of new cash injected into the US economy will be less and staggered over a longer period of time than what the currently hyped-up financial and investment markets are expecting. The net result is a classic “sell the rumour, buy the fact” as far as the recent USD sell-off is concerned. The US bond market is perhaps already selling that fact after all the QE 2 stimulated buying of a few weeks ago which drove the 10-year yield down to 2.40%. The bond yields are already trading higher at 2.56%. 

 

My view is that the equity, commodity and FX markets have become well ahead of themselves on what QE 2 can deliver to the US economy and their is an abundance of room for disappointment, and thus profit taking on the massive price shifts we have witnessed in recent weeks. Therefore the EUR/USD rate should reverse rather rapidly to $1.30 from $1.40, driving the Kiwi back to the low 0.7000’s. A downward correction in both equity and commodity prices should pull the AUD back a few cents from the tilt at parity to the USD last week.

 

Even though the FX markets have not been focussing too much on interest rate differentials as a driver of the NZD/USD value of late, the fundamental correlation cannot be ignored. The chart below confirms that the Kiwi is certainly over-extended at 0.75 and 0.76 compared to the two-year interest rate differential. I do not see our two-year interest rates going any lower and neither can the US two-year rates.