In nowhere land. That looks to be the NZD/USD at present and in 2023.
In the third quarter of 2022 I wrote that “the cycle will turn against the United States dollar, boosting the NZD/USD” – but also that the range for the NZD/USD looks to be lower than what we have experienced from 2000, aka, settling in the 60s and not the 70s.
A rapid rise in US interest rates pushed the USD higher over most of 2022, pushing other currencies lower. A higher USD provided some inflation relief in the US, exporting the problem elsewhere.
We waited for the potential for some emerging markets, saddled with a lot of US dollar debt, to crack. They didn’t. Asset prices cracked in 2022, bond prices rose a lot, but labour markets remained strong and emerging markets roared back late in the year. This was an odd interest rate cycle.
With US inflation now decelerating sharply, the US Federal Reserve is set to slow the pace of rate hikes and pivot. Market expectations are that US interest rates could be cut in late 2023 and 2024. That has buoyed risk appetites.
Cue a weaker US dollar from the fourth quarter of 2022, which has pushed everyone else up.
Maturity in the US interest rate cycle means the same for the US dollar. Interest rates are viewed to be either at, or returning, to more normal levels, in many nations.
China’s reopening has helped sentiment too.
The NZD/USD now finds itself trading around a level not too far away from fair value.
Neutral seems to be the common theme when assessing risk appetites (one key driver of the NZD) and the views of asset allocators. Commodity price are down, but far from out.
One key factor shaping the USD’s direction over 2023, and implicitly the NZD, will be resolution of the battle between the Fed versus the market.
Who is right? The Fed is saying rates will need to remain higher for longer. The market is saying a recession is around the corner.
Recessions are usually supported by policy accommodation from central banks. Core goods inflation is falling in the US, dictated by a weakening in used auto, apparel, and furnishings prices. Expectations are that service sector inflation will follow, particularly with new lease signings implying that rent/services inflation (a key contributor to inflation) is set to turn.
There are sceptics about inflation disappearing in a sustained fashion. A post-war trend of globalisation is reversing. We are in a period of rising geopolitical unease. With rising tension come pressures to increase defence spending and the reshoring of industries considered strategic. Security in food, energy and technology is driving policy with the economic driving force behind trade usurped by the geopolitical concerns. A less efficient trade world could be around the corner.
An implication of climate change is likely ongoing inflationary shocks, especially with food production.
Labour shortages are affecting wage gains and contributing to rising unit labour costs. The unemployment rate remains low, across the globe. The unemployment rate in NZ is 3.3%. It’s 3.5% in the US, 3.7% in the United Kingdom and 3.5% in Australia. Goods sector inflation has turned, service sector inflation has not.
For too long, politicians around the globe have failed to deliver on key areas such as infrastructure, inequality, climate change, housing, health, and education. The playbook now is that governments need to show spending restraint to curb inflation, when demands to raise spending in these areas has seldom been higher. We need those areas addressed, though.
Do we have a path to extract ourselves from quantitative tightening, the reciprocal of quantitative easing or printing money? Not really. Many sovereigns are vulnerable to rising interest rates and expect sovereign risk to be talked about more and more in 2022.
Locally, we have seen NZ’s current account deficit widen to 7.9% of gross domestic product. That is a national chequebook excessively in the red.
Recovering tourism numbers will help close it a bit. The real work will need done on the trade balance if we are going to get the current account down; we need to export more and import less, rotating growth away from the spending side of the economy towards the real productive sector. The hits the rural community has taken over the past few years will be felt in trade statistics for years to come. NZ is likely to need help from a sustained period below fair value for the NZD.
The NZD/USD dollar started 2022 at 0.68, dipped to 0.55, and ended at 0.63. Last year’s endpoint is as good a prediction as any for the end of 2023. It would require a degree of normality and stability. The problem is we reside in a non-normal and unstable world.
When it comes to the market versus the Fed, 2024 is when we will really know how sticky inflation is looking, and that will be a key influence on risk appetites, interest rates, the USD and implicitly the NZD/USD.
