Roger Kerr posted on May 31, 2011 01:26
A good number of local economists continue to have a view that the NZ economy is really struggling and the media lap-up their various woes of pessimism. However, tellingly, the markets are signalling to us something completely the opposite about the current and future outlook for the NZ economy. Consider the recent price action in the financial and investment markets:-
§ Foreign exchange market: The NZD/USD propelled up to near post-1985 float highs of 0.8215 as news reports stated that Chinese sovereign wealth funds were allocating another $6 billion to invest into New Zealand. Whether the news was correct or not was of no matter as currency speculators rushed to buy the Kiwi before the Chinese did! The popularity of New Zealand as an investment destination to meet their portfolio diversification needs is understandable with export prices and terms of trade at 30-year highs. The fundamentals of the NZ economy supplying protein to the massive urbanisation of Asia are very positive, and this is now being recognised by overseas investors with long-term investment horizons.
§ NZ Government Bond market: The considerable overseas investor demand for NZ Government bonds has driven the 10-year market yields down from 5.80% to 5.07% over recent months. The Asian sovereign wealth funds do not hedge the NZ dollar denominated bond investments i.e. they just buy the Kiwi dollar to buy the bonds and happily take the currency risk whilst they hold the bonds. The Government’s budget two weeks ago alleviating any concerns about a credit-rating downgrade for New Zealand.
§ NZ Equities market: Whilst not on a runaway boom, the NZ sharemarket has performed well over recent months with share investors clearly confident about earnings increases for listed companies in the current and future economic environment. Artificially low interest rates here (like the US) do distort the performance of shares, as buying shares for dividend yield is more attractive than cash in the bank on deposit.
§ Wholemilk Powder market: Fonterra’s confirmation of $8.10kg milksolids payout for the season just ended and a generally higher than expected $7.15 to $7.25kg milksolids forecast for the 2011/2012 season ahead has to be seen as very positive for the NZ economy going forward. Fonterra has confidence that the rise in international dairy prices over the past 12 months is sustainable.
The overall market pricing is signalling a strong economy and thus 4% plus GDP growth forecasts for next year have been given a tick as accurate and likely by the markets. The RBNZ could be well advised to take note of these market price signals rather than relying solely on the housing market as their key lead-indicator for inflationary pressures. As always, waiting for house prices to turn up before tightening monetary policy is a big mistake when the inflation risks are already increasing due to stronger than expected economic growth. There are signs already that farmers have started to spend again and even the OECD in their economic outlook for NZ last week see demand and spending picking up in the second half of 2011.
These markets tell me that the RBNZ and certain economists are underestimating future economic growth and are thus far too complacent on the future inflation threats. Business firms who have had compressed profit margins over the last two years (due to higher input costs) will be very keen to recoup those lost profits when end-demand picks up and they can increase their prices. Higher wage settlements and higher KiwiSaver employer contributions are two of those increased input costs. Price-setting behaviour is about to change.
Three year fixed-rate money (three-year swap rates) at 3.80% looks startlingly and artificially cheap against this scenario of stronger growth and an annual inflation rate above 3.00%.
NEW ZEALAND DOLLAR MARKET COMMENTARY
Kiwi dollar divergence from determinants unlikely to last
Is the heavy buying of NZ dollars that boosted the NZD/USD rate from 0.7800 to 0.8200 last week, “hyped-up hot air” that could reverse just as quick, or real and permanent capital inflows? My gut feel is the former as I do not see the rumoured $6 billion of Chinese investment funds turning up in NZ any day soon. The speculative buyers will be keen to take their profits (i.e. become sellers of NZD’s) when they realise that the real money is not materialising in the timeframe they expected. The short-term FX market, however, may be keen to break the post-1985 float highs of 0.8215 recorded in mid-2008.
My view is that the latest bout of NZD strength to 0.8200 is unsustainable as the NZD/USD has de-linked over this last month from its main drivers (see charts below). I expect the NZD to return to its close historical correlations i.e. retreat back to below 0.7800 in the short term and on to the low 0.7000’s within a few months. Most of the lower NZD view is driven by a stronger USD view to below $1.4000 against the Euro over coming months. Domestically, the “no downgrade” credit rating outcome and the greater likelihood of increasing NZ short-term interest rates later this year have to be seen as NZD positive whichever way you look at it.
The National Bank of NZ Business Confidence survey results will also be positive with improving confidence levels. On the other side, stronger than expected US Non-Farm Payroll employment figures on Friday will provide support for the USD itself. The RBNZ’s Monetary Policy Statement next week on June 9th should again see Governor Bollard jaw-boning (if he is consistent!) the Kiwi dollar downwards. The RBNZ are again likely to be more dovish on the NZ economy than what the financial markets are currently signaling.
Historically, the NZD/USD exchange rate has never de-linked from its correlated drivers for very long. This time is no different.