Thursday, August 11, 2022

Good times may be over for NZD

Seismic shifts in global economics are exposing fault lines in New Zealand’s economy, possibly heralding a sustained correction in the NZD, writes Cameron Bagrie

Could the New Zealand dollar be moving into a lower trading zone on a sustained basis?  I suspect so.  

A byproduct of rising volatility, higher inflation and rising interest rates in the United States has been a lower NZD.

Being down has not been across the board.  The move has been against the US dollar. The Euro/USD is around parity and the USD/Japanese yen has soared.  Against other currencies, the NZD has broadly trodden water while the greenback has soared. 

Back in the 1990s the NZD/USD rarely hit 0.70.  In the past 20 years it has been above 0.70 about half the time – and 60% of the time in the past decade.  It has traded in a higher range for a long time.

Fair value estimates – where the currency is expected to oscillate on average – lifted from the low to mid-60s to about 70 cents.  The new range became 60-80 rather than 50-70 (with even a fall to 40 cents).

The cycle will turn against the USD, boosting the NZD/USD, but what if the range for the NZD/USD is also turning back lower?

NZ has benefitted from a gargantuan rise in the terms of trade (the ratio of export prices to import prices) for decades.  NZ’s terms of trade are about 40% higher than they were in the 1990s.  Food prices have outdone manufacturing prices.  Rising terms of trade have supported a higher currency on average.

The hope is that the trend continues.  It faces challenges, though.

Globalisation supported cheaper outsourced manufacturing production. But outsourcing is now being replaced by insourcing, to secure supply chains.  Many countries’ cost advantages in manufacturing have also been whittled away. 

Inflation is rampant, forcing up costs, particularly for input-heavy manufacturing items. 

Food inflation is also rising, though this faces a political constraint; people need to be able to afford to eat.

Manufacturing item price suppression has been assisted by rapid technological advancement. That will continue, and such adoption will likely broaden into food with rising costs forcing change.       

The current account, or NZ’s chequebook with the world, is in the red.  A $23 billion deficit has been recorded in the past year, 6.5% of gross domestic product. 

Some temporary factors are at play.  Absent inbound tourists, the services balance is in deficit.  A booming economy has also boosted goods imports.  Exports have risen, but not as fast.

Read: Low NZ dollar may stick around

We face three significant long-term challenges, two modest and one major. 

The first minor one concerns rising interest rates, which add to borrowing costs.  NZ has a net liability position with the rest of the world of $160bn.  

And it will take a long time for the tourism sector to recover.  In the meantime, New Zealanders are off travelling overseas. Seventy-three thousand visitor arrivals were recorded in May, whereas 110,000 NZ residents departed on holiday. 

The major issue is the path for export growth. Pastoral export growth has historically been about 6% a year, with dairying closer to 7%.  

The projected path under the government’s “fit for a better world” is roughly half that.  Production constraints hurt. That could be very negative for the goods trade balance and current account balance if import growth does not slow, or we unlock alternate export opportunities.

Failing that, the NZD will need to adjust lower. 

The benefit of booming terms of trade over a long period, and, more recently, covid-inspired sugar candy economics from the Reserve Bank and government – which supported growth –  have camouflaged four key problems, which are now being exposed.

The first is weaker productivity growth.  Productivity growth across the market (think business) sector has averaged 0.6% for the past five years and never been above 1% in any year.

The second is under-investment in people.  NZ has become accustomed to filling its boots with migrants from offshore.  Cue glaring holes in areas such as nursing.  The world is rushing to fill those same holes, and they pay more. We are losing non-residents in droves.

If the NZD is the share price of NZ Inc, employees appear to be bailing, never a good sign.  An estimated loss of 10,700 people has been recorded in the past year. 

The third is poor infrastructure, and the management of many assets that has now morphed into the Three Waters debacle.  Health reform is likely to end up similar to the consolidation of the polytechnics.

The fourth is poor policy that has lasted through multiple governments.  A housing crisis, failing education standards and dilapidated infrastructure straddle election cycles.

The US and the USD face challenges too, in the form of a high level of government debt and large current account deficit. The “empire” of the 20th century is showing signs of being well past its peak, just as the Roman and British empires eventually faded. 

If the USD were not the reserve currency, all bets would be off. It is difficult to see anything on the horizon to replace it, though.

The bottom line is that there are many temporary cyclical factors that have driven the NZD/USD lower – largely dictated by the greenback – and this will reverse at some stage.  Structural factors could have an influence over the coming years, too, capping the bounce.  NZ’s economic story has huge fractures, and the NZD will reflect that over time.

Bagrie Economics uses all reasonable endeavours in producing reports to ensure the information is as accurate as practicable, but shall not be liable for any loss or damage sustained by any person relying on such work whatever the cause of such loss or damage. The content does not constitute advice.

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