Exodus begins from crowded US dollar long trade

  • Summary of key points:-

  • Weaker-than-expected US inflation sparks massive reactions in financial markets
  • RBNZ has no choice but to tighten monetary policy further
  • Australian and Chinese influences are also important for the Kiwi Dollar

Weaker-than-expected US inflation sparks massive reactions in financial markets

Pressure had been mounting in global currency markets in recent weeks, causing the sentiment of “one-sided betting” and the belief to buy and hold US dollars to begin to wane, as in evidenced by recent upside volatility between 110 and 114. on the Dixy USD index (see chart below).

Currency markets were showing uncertainty as to whether the strong USD bullish trend, ongoing since the start of the Russian-Ukrainian war in February, was running out of steam. However, he needed a special catalyst to break the bulls in the dollar and stimulate the aggressive selling of the dollar. Last Thursday’s US October CPI inflation figures provided that trigger, with the monthly increase in core inflation coming in at just +0.30% from earlier forecasts. consensus from +0.50% to +0.70%. Stock markets rallied strongly, bond yields fell and the US dollar took a big hit as holders of speculative long USD positions all rushed for the exit door. What the financial markets instantly reflected was the belief that US inflation had finally peaked and that the Federal Reserve should soon change its tune and start pausing on rapid interest rate increases to tighten monetary policy. Evidence of a sharp slowdown in the US economy and demand better matching supply has accumulated to the point that markets are now convinced and price in the inevitable Fed pause on monetary policy.

The US dollar nosedived 6.00% over the past eight days, falling from 113.00 on the Dixy index on November 3 to a close of 106.25 on November 11. As a result of the widespread selling of the dollar, the NZD/USD exchange rate climbed 6.30% from 0.5750 on November 3 to 0.6115 today. The Kiwi Dollar’s historic “dip and rally” pattern has indeed repeated itself as we expected.

Local USD exporters who have continued to maintain their forward hedging levels at maximum policy limits over the past few months by replacing all maturing hedges at exchange rates between 0.6000 and 0.5550, have been well rewarded for their patience and discipline in risk management. High levels of hedging will need to be maintained going forward as the massive unwinding of long dollar positions “still has a ways to go” (to quote the world’s top central banker). As pointed out earlier, the fact that we are in November and close to the end of the US financial year on December 31 will provide more incentive for speculative hedge funds to close their USD positions before the USD weakens further and reduces. their profits. The tide has finally turned on the once strong US Dollar and further USD selloffs are to be expected over the next few weeks. Under these drastically changed global currency market conditions, the Kiwi Dollar could easily trade higher at 0.6400 or 0.6500 by the end of the year or early next year.

Adding to the rapidity with which economic conditions have collapsed in the United States in recent months, last Friday’s survey of Michigan consumer confidence for November fell from the previous level of 59.9 to 54.7. . High inflation and much higher interest rates have hit US consumer spending hard, so it will be a tough Christmas for retailers. The figures for retail sales in the United States for the month of October are published this Wednesday, November 17 and we had to expect a result well below the consensus forecast of +0.90%. The US housing market has crashed into recession and the negative “wealth effect” of falling house prices will now translate into much weaker consumer demand. Ultimately, the main contributor to the current high underlying inflation in the United States, housing rents, will also decline sharply. However, there is a considerable lag with the rent data, as evidenced by the inflation figures for October, where rents were still rising by 0.70%.

RBNZ has no choice but to tighten monetary policy further

The priorities and decision-making of the RBNZ have come under intense media and political scrutiny in recent weeks with the reappointment of Governor Adrian Orr for another term and the release of the RBNZ Performance Review Report !

The next monetary policy statement from the RBNZ on November 23 will therefore attract more attention than usual. There is no doubt that the fight against rising inflation is not yet over for the RBNZ, despite the Governor indicating a few weeks ago that he was nearing the end of the tightening cycle. The RBNZ now faces a severe surge in wage inflation as labor shortages in the public and private sectors reach acute levels. Hourly wage rates rose over 7.00% in the September quarter and companies are being forced to pay a lot just to attract and keep staff. The question is whether the so-called independent central bank will directly address the root cause of the wage inflation problem, i.e. call out the government for its botched immigration policy in the post-Covid era that created labor shortages. It may be asking too much of the RBNZ to identify and address the underlying causes of inflation, as it has failed miserably to recognize the reasons for the consistently high non-tradable inflation (domestic inflation) over the of the past 10 years, i.e. government bureaucracy, legislation and regulatory compliance.

Expect a more hawkish tone from the RBNZ and this should generate further buying of New Zealand dollars. Looking to next year, in addition to the general depreciation of the dollar in global currency markets, the New Zealand dollar may attract buying interest on its own as interest rate differentials with the dollar widen. Currently, the New Zealand two-year swap interest rate at 4.95% is 0.50% above the US two-year rate of 4.45%, which is not wide enough to attract investors. foreign investors to the kiwi dollar. In mid-2023, the US Fed will cut interest rates as inflation falls as fast as it rose in 2022. Due to stiffer and more permanent wage inflation in New Zealand, the RBNZ will need to maintain higher interest rates for longer into 2023. The bottom line is another positive for the NZD as the interest rate differential between the US and New Zealand widens. potentially widens to 2.00% and attracts foreign flows to the Kiwi Dollar. We haven’t seen independent strength in the NZD for some time, but the double whammy of a weaker dollar and widening interest rate spreads point to sustained gains for the New Zealand dollar next year. .

The expected appreciation of the New Zealand dollar will come at a time when the New Zealand economy itself looks a little sicker, with export prices currently falling and the domestic economy already in recession. Local USD importers should keep hedging levels to a bare minimum with expected NZD gains and declining currency exposure expectations due to the weak economy.

Australian and Chinese influences are also important for the Kiwi Dollar

The NZD and AUD remain highly correlated to the currency value of the Chinese Yuan due to economic interdependencies. The value of the yuan reversed dramatically last week from over 7.30 against the USD to 7.09 as the USD weakened and China announced some adjustments to its Covid Zero policy with reduced quarantine times. Further progress in easing their strict Covid policies will be positive for the Yuan, and therefore also positive for the NZD and AUD.

The Aussie dollar lagged the NZD’s gains against the US dollar as the RBA’s rise towards the RBNZ slowed with interest rate increases. The RBA will be forced to revise its “go slow” monetary stance if forthcoming economic data proves that inflation continues to rise. Australian wage data on Wednesday will be important in assessing whether inflation is peaking or not. September quarter wages are expected to rise 1.20%, much more than before. Australian employment figures the following day, Thursday November 17, will confirm that their labor market also remains tight. The next meeting of the RBA to decide on the setting of interest rates will take place on Tuesday, December 6. A less dovish stance from the RBA than markets expected would see the NZD/AUD cross rate give up some of its recent gains from 0.8750 to 0.9140.

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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.

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