Summary of key points:-
- Interest rate hikes in the United States are belatedly shaking up all the markets – except the foreign exchange markets!
- Australasian inflation data is at the center of short-term concerns for local currency markets
- NZD/AUD cross rate reverses sharply lower
Picking when US stock markets would correct lower due to rising US interest rates was always going to be nigh on impossible. The retail stock investors, wholesale stock investors, fund managers, stockbrokers and investment banks that power the new quotes have all been in total denial for quite a long time after inflation started increasing in early 2021.
The inflation watchdog, the US Federal Reserve, has also been inflation denying for much of 2021 as it has stubbornly stuck to its view that price increases were just temporary (“transient” being their preferred description). A belated and abrupt realization that inflation was much more permanent caused the Fed to shift its monetary policy to a decidedly more hawkish stance in mid-December. That was if stock markets needed to be officially told by the central bank that interest rates would rise permanently in 2022 and 2023 before changing their investment strategy from long to short.
They clearly did not determine the inevitable from the signs of inflation themselves. US bond markets were equally guilty of being in denial, as evidenced by the rapid rise in 10-year Treasury yields from 1.50% to highs of 1.90% last week.
The sharp rise in long-term interest rates is having a negative impact on corporate valuations, especially big tech stocks which have come under heavy criticism from arguably over-hyped valuations before.
Cryptocurrency values have also been reduced over the past week, another sign that speculative investors at all levels have been uncovered, just as the Emperor turned out to be wearing no clothes when the tide s is removed.
US interest rate markets are now pricing in four 0.25% Fed hikes this year, starting in March. At the end of December, the futures price forecast three increases of 0.25% from June. Interest rate markets may have gotten ahead expecting the Fed to hike rates sooner and harder. We’ll get a read on the Fed’s monetary policy tightening schedule later this week when they meet Thursday morning (NZT).
Markets price in that the Fed has achieved its full employment target with the US unemployment rate now at 3.90%. However, other measures of the US labor market such as the participation rate (number of workers and job seekers) indicate that there is still some way to go to reach the goal of full employment. Non-farm payroll employment increases in the past two months (November and December) have been well below previous forecasts and jobless claims (jobless claims) have been higher than expected in recent weeks . As a result, equity markets could get a reprieve later this week when the Fed fails to approve the more aggressive interest rate hike track that markets are predicting.
The “risky” sentiment in the investment market last week hurt the Kiwi Dollar as it failed to hold gains above 0.6800 and tested the strong support level of 0.6700. A major downside correction in the stock market has always been the risk we cited in our opinion and expect the NZD/USD rate to hold above 0.6700 and return to rates above 0.7000 on a weaker dollar in global currency markets. Tellingly, the US dollar itself was unable to strengthen due to rising US interest rates and the buying of safe-haven dollars in plummeting stock markets.
Currency markets are behaving as expected, with the dollar’s gains against all currencies from March to November last year fully pricing in advance of tighter Fed policy and impending interest rate hikes. ‘interest.
Recent changes to the FX market’s speculative positioning on the US Dollar confirm our view that the USD has ended its uptrend and is now poised to weaken over the next few months.
Net speculative long USD positions (expecting the USD to strengthen) as measured by the CFTC are at their lowest level since September 2021, with long positions down from $19.3 billion to 12, $7 billion last week. Further USD selling should be expected this week if the Fed goes slower than the markets on interest rate hikes.
The Euro’s gains against the USD at $1.1350 may also suggest that European investors are abandoning plummeting US equities and returning their funds home, i.e. buying gold. EUR, by selling USD.
Many U.S. fund managers are now signaling they are reducing their weighting to U.S. dollar holdings as they embrace the 2022 outlook that the U.S. dollar value has already priced in interest rate increases and that from from there, the forex markets will turn to the most negative. US economic factors (e.g. large internal government budget deficits and large external current account deficits).
The net result of these changes in the global market and resulting capital flows is that the NZD/USD exchange rate should hold above 0.6700 (currently 0.6720) and recover to 0.6800 and 0.6900 as the USD weakens further and the Australian Dollar (which we are tracking) is a major beneficiary of funds exiting the USD.
Australasian inflation data is at the center of short-term concerns for local currency markets
How Australia managed to record an annual inflation rate (currently 3.00%) well below the 4.9% in New Zealand and the 7.00% in the United States is a mystery.
They have seen the same increases in oil prices, commodity prices and freight/shipping costs as New Zealand and the US over the past 12 months. It’s not as if the Australian economy has dramatically higher levels of competition in industrial sectors that produce the result of lower inflation.
Perhaps the difference is only temporary, and we are about to see a big catch-up with the Australian inflation numbers.
The rate of inflation for Australian non-traded goods (domestic prices), however, is well below the constant price increases we are experiencing in New Zealand from the government sector and non-competitive parts of the economy. Lower inflation to date is the main reason the Reserve Bank of Australia has maintained its outlier stance of not raising interest rates until the end of 2023.
The consensus forecast for Australia’s December quarter inflation increase, due out on Tuesday, January 25, calls for an increase of 1.00%, raising their annual inflation rate slightly to 3.20%. A result above this will push the Australian dollar higher.
Inflation data for New Zealand’s December quarters is released on Thursday January 27 with a 1.20% increase for the quarter forecast, bringing the annual rate to 5.60%. A result in line with expectations should be positive for the Kiwi Dollar on the day as it will confirm to the markets that the RBNZ needs to tighten monetary policy aggressively.
However, once inflation peaks in New Zealand, you wonder how the RBNZ will react to the gathering evidence of a slowing economy, a weaker housing market and a low level of business and consumer confidence.
NZD/AUD cross rate reverses sharply lower
In September last year, when the NZD/AUD spot rate was trading above 0.9600, we released a special cross rate report, which incorporated a strong view that history would repeat itself and that the NZD/AUD rate would depreciate to return to 0.9300/0.9200. Region. Local banks at the time expected the opposite to happen with further NZD gains at perhaps parity with the AUD.
History has indeed repeated itself with the AUD outperforming the NZD against the USD in recent weeks and the NZD/AUD cross rate falling to 0.9350.
The underlying reason for the NZD’s underperformance is that the RBNZ started signaling monetary policy tightening in November and the RBA has yet to do so. FX markets had fully priced in advance of the NZ interest rate hikes in September and October (so NZD stronger then), whereas the AUD market is only now .
FX markets operate months ahead of expected events and that is why the AUD is making gains against the NZD as the shift in RBA policy direction is expected and priced in now.
Over the past seven years, there has been a consistent five cent spread between the AUD/USD exchange rate and the NZD/USD rate. By September 2021, the spread had narrowed to just three cents with the AUD/USD spot at 0.7300 and the NZD/USD spot at 0.7000. Today the spread is down to 4.60 cents with AUD/USD trading at 0.7180 and the Kiwi at 0.6720. The current spot rate of 0.9360 NZD/AUD is likely to fall again over the next few weeks as the RBA is forced to change its rhetoric on the timing of the inevitable interest rate hikes when the next statement is made. February 4.
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*Roger J Kerr is Executive Chairman of Barrington Treasury Services NZ Limited. He has been writing commentaries on the New Zealand dollar since 1981.