Summary of key points:
- “Risk-off” equities sentiment hurts the Kiwi dollar
- Debunking the myths about the causes of our high inflation
“Risk-off” equities sentiment hurts the Kiwi dollar
The last week has been a right nightmare for Kiwi dollar bulls, the NZD/USD exchange rate falling sharply from above 0.6800 to 0.6630.
It started on Easter Monday with weaker than expected Chinese economic data sending both the Kiwi dollar and Aussie dollar down as slower Chinese demand is not good news for the two commodity currencies whose economies are heavily dependent on China for trade.
The week ended with global equity markets taken further fright to the growing economic uncertainties from high inflation, sharply higher interest rates and an escalation in the Russian/Ukraine war. US share markets fell 3% on Friday 22 April and they have dropped four weeks in a row as they reflect the growing “risk-off” uncertainties surrounding the outlook for the US economy. The Federal Reserve believe that the US economy is sufficiently robust to handle the higher interest rates now being implemented without tipping it into recession. However, consumer confidence crashing is one indicator pointing to more of a hard landing for the US economy than a soft one at this point.
We witnessed a similar rapid sell-off in US equities in the second half of January with the Dow Jones Index plunging 6% over a two week period. The “risk and commodity” currencies, the NZD and AUD were consequently punished with the Kiwi dollar depreciating from 0.6860 to a low of 0.6530 over that two week period. The impressive NZ dollar recovery that followed up to a high of 0.7030 on 5 April was due to commodity prices lifting after the Russian/Ukraine war commenced in February. The equity market sell-off risk for the Kiwi dollar is always present, however the risk goes both ways, with more favourable “risk-on” sentiment in equities generally pushing the Kiwi higher.
The near term direction of the NZD/USD exchange rate is once again in the hands of equity market sentiment and whether the US economy can handle the necessary aggressive monetary tightening from the Fed. Upcoming US data will need to prove that the economic activity levels are holding up and that there are signs of inflation increases peaking-out. A positive US GDP growth number for the March quarter on Friday 29 April and PCE inflation data on the same day have the opportunity to restore some equity investor faith on both counts. The following Friday, 6th May US employment figures for the month of April should again be another strong increase of over 400,000 new jobs.
While the NZD/USD rate has broken below key technical/chart levels at 0.6700, the positive fundamentals of higher interest rates and higher commodity prices do not suggest continuing NZD selling. Off course, such a view is predicated on the investor risk sentiment in equity markets recovering from here. Global fund managers and hedge funds should be attracted back into equities at the lower values now available as the alternative investment asset class of bonds is a train-wreck of plummeting values. In this challenging investment environment it is understandable that hedge funds and investment banks are eyeing commodities as an alternative investment asset that will hold its value. Adding to the positive commodity story will be significant monetary and fiscal policy stimulus in China being just around the corner.
The dominating influence over the NZD/USD movements remains the daily direction of the AUD/USD exchange rate. Local Australian political risk factors ahead of the 21 May election date and the current investor “risk-off” sentiment has pulled the Aussie dollar back four cents from 0.7650 to 0.7250 over the last three weeks. The AUD selling is well over-done, in the author’s opinion, against the medium term and impressive Australian economic backdrop of 4.5% GDP growth this year and continuing massive external Current Account surpluses.
Perversely, NZ Finance Minister Grant Robertson’s budget on 19 May stands as another potential Kiwi dollar positive as he irresponsibly increases Government spending which will add to the already high inflation rate. The Robertson budget, in turn, prompting additional monetary tightening from the RBNZ as Robertson ignores Orr’s warnings that monetary policy needs fiscal policy as a friend, not a foe.
Debunking the myths about the causes of our high inflation
It has been very frustrating over recent weeks observing the shallow and superficial level of debate locally as to why New Zealand’s inflation rate is 6.9% and what can be done about it.
The analysis and understanding from the media, politicians, economists and various commentators has, in my humble view, failed to address the core crux of the matter i.e. the complete picture of the source of the high inflation. They have all made the same mistakes in attempting to identify the reasons for the sharply higher inflation rate at this time.
Mistake # 1: The high inflation is something very recent. Wrong! It is not new, the non-tradable, domestic inflation component of the CPI has been running at over 3.00% every year for the last 15 years. What everyone forgets about (not this column!) is that tradable inflation was low or negative from 2012 to 2020 due to imported deflation and this disguised the constant home-grown inflation. That Government policies will add to inflation over the next few years (as one prominent economist opined last week) is misleading, they have been causing the problem for 15 years!
Mistake # 2: It’s all the fault of profiteering supermarkets and oil companies. These sectors are very easy and visible targets for the lazy analyst. The facts are that both these retailers merely add a margin onto core product costs to distribute throughout the land. Commerce Commission investigations showed no evidence of increased profit margins or excessive returns on capital over recent times. These distributors are not the root-cause of our higher inflation.
Mistake # 3: It all comes from offshore, therefore not our fault. The Prime Minister likes to shift blame away from her Government for political purposes. However, successive Labour and National Governments over the last decade have allowed excessive regulatory and compliance costs to be imposed on the economy which households end up paying for. Local Government rates have increase on average 7% every year or 10 years, property maintenance is up 4.5% pa average and house rentals up 3% pa average.
Mistake # 4: It has nothing to do with Government. Wrong again. The public sector (including local government) is a reasonable chunk of the NZ economy and as they are forced to increase their costs to carry out Government policy on climate change, health and safety, water and carbon emissions they recoup the extra costs with increased prices to business and consumers. There is no market discipline of competition to control inflation coming out of the public sector.
Mistake # 5: NZ is a small/inefficient economy suffering from low “economies of scale”. That myth needs to be debunked as well. How can we have the most efficient grassland farmers in the world, however the most inefficient economy when it comes to distributing goods and services (particularly food). Unfortunately, we do have too many “middlemen” taking their cut in the NZ domestic economy. An old rugby mate of mine had a great business importing plastic clothes pegs from China and selling them to the supermarket chains. Who don’t the supermarkets buy direct and reduce their prices by the middleman’s profit margin?
Suggested solution: Rather than just identifying the problem and blaming the Government, opposition political parties should be coming up with solutions to reverse the out of control home-grown inflation of our own making. In 1995, our Finance Minister at the time Ruth Richardson sponsored the Fiscal Responsibility Act to hold all Governments to account on spending and budget deficits. Perhaps we need a “Public Sector Price Control Act” that requires every piece of Government legislation and regulation to first pass a test of whether it increases costs on average households. Such a “straw-man” test or reference household test would return some accountability and transparency to the public sector that has been absent for a long time.
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*Roger J Kerr is Executive Chairman of Barrington Treasury Services NZ Limited. He has written commentaries on the NZ dollar since 1981.
35 Comments
For as long as I can remember NZ finance ministers & RBNZ governors have lamented the poor savings record of New Zealanders as a society. Yet when covid struck the OCR was lowered to ground level, despite that tool having already run out of any productive course, and New Zealanders were being encouraged to borrow to spend to save the economy and in this the government itself led the charge. There it is, and here we are now.
HouseMouse,
One thing you can never accuse Roger of is understating his own superiority.
"The analysis and understanding from the media, politicians, economists and various commentators has, in my humble view, failed to address the core crux of the matter i.e. the complete picture of the source of the high inflation. They have all made the same mistakes in attempting to identify the reasons for the sharply higher inflation rate at this time."
Humble he is not. It seems that absolutely everybody but him has missed the considerable divide between tradable and non-tradable inflation in recent years. So are so lucky to have him to point this out.
Our political leaders are doing, & have done for a long time now, a very poor job indeed. Politicians don't know how to balance the budgets of their own households let alone the country's books. And as for creating wealth & being able to afford all the new toys & technologies, there is no one inside of parliament that would know where to start, let alone get the general direction right. There's no question this Labour Govt has a radical agenda, when looking at the average Kiwi. All they do is add costs, without benefits & I include 3 waters in this. The only benefit 3 waters brings is bigger borrowing at lessor rates. Terrific. More debt, more bureaucracy & still more costs - for better water? 90% of our drinking water is okay already. The pipes don't look too good, but the water is okay. If local government had its act together we wouldn't be discussing this. But once again, poor leadership showing it's ugly side, which has been going on for a lot longer than 15 years Roger. Sadly.
Something has been seriously wrong with the NZ economy when it is much more profitable to buy a house, leave it empty and then sell it making much more money than investing money into productive enterprises.
This is a result of poor policies implemented by Labour and National over the last 20 years or so.
Yes when houses are going up at the same pace or faster than income from worked labour (that in theory determines the affordable price of housing), you know you have a serious issue on your hands.
House price rises should be a fraction of the average income on an annualised basis..not a similar value or even greater! If they are, in means you are living in a period of (insane) excessive speculation which is a recipe for eventual financial crisis. It means you are stealing cash flows from the future, to justify price increases in the present.
A great article. It is sport for nz bureaucrats and politocrats to be responsible for everything that goes, well and not responsible for anything that screws up. Lets see 15% inflation and the ashes of housing market. Lets see a few politocrats and bureaucrats, figuratively hanging from a few lamposts. Out of that destruction will come a better NZ and a reponsible ruling class. Lets see the hard working taxed nothing and feudal class taxed everything. Bring on the revolution ushered in by inflation.
A market that had far less state intervention would have corrected itself by now.....providing fairer prices, smaller mortgages for FHB's, less debt/leverage and greater financial and social stability.
Everything that governments and central banks have done GFC-now have done the opposite of the above.
Reagan is perhaps right....that government is the problem, not the solution.
I don't blame New Zealand for embracing non-tradable inflation but clear that trend of tradable inflation at 0% is over. We are now seeing an internationally reflationary environment which means we must adjust interest rates appropriately. This will tend to revalue cashflow in relation to asset values which will resolve many other issues within the economy, including the property bubble. Governments fiscal prudence will improve as interest rates rise (unless we live in the next Argentina.)
Greenflation was always coming and it's unavoidable.
US Recession, I'd keep an eye on the Sahm Rule: "Sahm Recession Indicator signals the start of a recession when the three-month moving average of the national unemployment rate (U3) rises by 0.50 percentage points or more relative to its low during the previous 12 months."
This is one of my favourite 'Roger J Kerr reckons...' articles to be fair. Anyway, despite having wildly different political views, I have to say that I agree with a couple of the points. Let's break it down....
Mistake # 1: The high inflation is something very recent / tradable inflation has been running at 3% etc. This is a really important point - we have spent the last 15 years relying on zero / negative inflation on imported goods. This has enabled higher wage growth and prices domestically that have gone under the CPI radar. Sadly, it has also allowed us to shovel more earnings into houses and rent, so most of us haven't noticed the difference.
Mistake # 2: It’s all the fault of profiteering supermarkets and oil companies. Jeez, I hate this binary framing from the left and the right - it always has to be ALL the fault of someone (typically evil big business or Govt depending on your viewpoint). It is crystal clear that corporate profits, dividends, and share buybacks have exploded in the last couple of years - corporate tax revenue is through the roof (so profits must be too). Companies with market power have used that power to increase their profits. Is this ALL the reasons prices are higher? No, of course not. But it is part of the story.
Mistake # 3: It all comes from offshore, therefore not our fault. Agreed - see local Govt rates and major rent hikes that should be regulated. I think commentators and Stats NZ CPI weightings also underplay how much oil prices wash through into domestic prices, but that's splitting hairs.
Mistake # 4: It has nothing to do with Government. Now this depends! Underfunding local Govt and allowing rates hikes of 7% per annum? Guilty as charged. Bidding up the price of building things through poor procurement practice - yep, that too (any decent-sized corporate would buy the supplier of mission-critical products). Under-regulating landlords and allowing them to extract ever higher rents and Govt subsidy on crap, damp housing? Yes. Definitely. But, simply spending too much? Nope.
Unsurprisingly, the article ends with the libertarian right's default solution to anything and everything - smaller Govt and stripping away regulation (by, errrm, introducing a new piece of regulation). Our economy is too complicated for these idealogical magic bullets. Maybe we could shrink Govt departments and regulation considerably by giving all adults tax credits and introducing a flat tax on all earnings (and on land and carbon)? But, maybe Government might need to grow in other areas - e.g. building the capacity to build housing and other critical infrastructure?
Maybe, Govt should actually have some kind of plan for the future and work out what regulation needs to be removed or taken away to get there?
Good comments.
As I say higher up, Roger makes some very good points, and some very questionable ones, in this article.
Glad you took the time to expand and saved me the bother ! (many of my thoughts were similar to you)
He's certainly very ideological in his views - often simplistically so - which I think detracts from many of his pieces (which often have some good things to say)
It was indeed surprising that an A.C.T. politician had a thought. Usually they just chant mantras: government bad, private good. Government spending bad, private spending good. Progressive taxes bad, consumption taxes good. Government regulation bad, private exploitation good.
Yea, so.. I agree with all of this? There's a lot of cowardice from people on $200K a year who don't want to accept we might have some structural issues that their continued employment needs are best served by baking even further into the system, or that getting by in NZ is rapidly becoming too hard for a huge (and rapidly rising) number of middle class Kiwis
I see people screaming for a return to the days of the Ministry of Works - what about the Auckland Light Rail project (whether you disagree with it or not) suggests that anyone in NZ knows how to build anything? Government has simply forgotten how to do anything except wag their finger in our face and charge us over and above the rate of inflation (that they mandate into existence) for the pleasure of doing so.
If you are young, a salary or wage earner or you don't own real estate, then NZ does not care about you, and will not care about you. If our politicos could say that to your face without fear of never getting elected, they would, in a heartbeat.
Controlling inflation through sensible monetary and fiscal policies, and managing government spend below the 35% heading to 40% under this government
The damage about to be caused by high interest rates could be mitigated by a smaller public service with less PR hacks troughing on the taxpayer, while throwing massive amounts of unmeasured money at it (Think of 1.9bn mental health as SPENDING, not INVESTMENT and you have the picture - investment requires meaningful results and a return on that investment)
NZ'ers could retain their employment and incomes because they would have their own money to spend how they need to, and inflation would moderate because the government could reign in their spending and not add as many costs to the business owners. Of course, there is a FAT CHANCE of this ever happening under Labour, so troughing and taxing here we come. But it's OK, the benefits are bigger, so those losing their incomes will be well looked after by those others being taxed higher (and adding the extra costs of Robertson's insurance scheme given that Welfare is already funded through tax and unemployment is apparently at record lows so its a straight tax gain.......)
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