RBNZ governor playing a tricky game with NZD
- Tomorrow’s NZ government budget may have some impact on NZDUSD
- In New Zealand the governor personally commits to achieving an inflation target
- Wheeler needs the exchange rate to decline for inflation to rise
By Max McKegg
There’s not much data on the economic calendar down under this week and both the Aussie and Kiwi are being driven by global factors, principally those influencing the chance the US Federal Reserve will raise its rate target in June (now 35% odds) or July (55%).
But for NZDUSD, tomorrow’s government budget may have have some impact, mainly around the economic forecasts contained in background documents.
Although its not an election year, Finance Minister Bill English has room for a few populist initiatives because the economy has been performing at its potential for some time and the budget projections are likely show further reductions in government debt over the next few years. Hence the International Monetary Fund’s assessment that New Zealand’s structural balance is sound.
Not so relaxed about the situation is Reserve Bank of New Zealand governor Graeme Wheeler. At most central banks, monetary policy is determined by committee, but in New Zealand the governor personally commits to achieving an inflation target, currently set at the mid-point of a 1% to 3% range.
However, the actual rate of inflation has been running closer to zero for the last 12 months, and even on the RBNZ’s own forecasts it won’t reach target until early 2018.
With such a poor track record, Wheeler can be grateful he is not held to the same performance standards as English Premier League football managers.
It's all in the tactics
In his April 28 monetary policy statement the governor said “Further policy easing may be required to ensure that future average inflation settles near the the middle of the target range”.
Markets jumped on this as guidance the policy rate of 2.25% would be cut again, probably on June 9 when the RBNZ will present updated economic forecasts. Money markets priced in an 80% chance of a cut.
Louis Van Gaal at Manchester United. Photo: Flickr
But as of today the odds have dropped closer to 20%. Why the change ?
Largely because traders think Wheeler is playing a tactical game. He wants/needs the exchange rate to decline if he is to have any chance of inflation hitting target, and the NZDUSD cross is an important component.
But if the US Federal Reserve obliges by getting back into rate hiking mode, then a stronger US dollar will drive NZDUSD down and Wheeler will be able to keep his powder dry.
The chart below (click to enlarge) illustrates the tricky position he’s in. The policy rate has been cut five times over the last 12 months, on the days marked by the vertical lines.
But it's clear the impact on the currency – as represented by the Trade Weighted Index (TWI) – has been mixed. Certainly a rate cut does not guarantee the exchange rate will fall.
NZ Trade weighted Index
The second feature of the chart is the horizontal step lines. They represent the path the exchange rate needs to take under the RBNZ’s forecasting model if the 2% inflation target is be be reached (all else being equal).
But at around 73.00 today, the TWI is well above where it should be: Enough to knock 0.3-0.4% off the already low inflation rates projected by the Bank in the next couple of years.
The RBNZ’s next policy review will be on June 9, a week before the Federal Reserve. So if Wheeler passes on a rate cut this time around, it will be a punt on the Fed obliging with a rate hike on June 15, or at least a strong signal of a move at the July meeting.
In the best of all possible worlds, Fed chair Janet Yellen would step up to the plate in a speech scheduled for June 6 and make an unequivocal commitment to get back on track with normalisation of monetary policy, sooner rather than later. Conventional wisdom is that NZDUSD would fall in that scenario.
But these days a widening of the interest rate differential, either from a hike for USD and/or a cut for NZD, is not a guarantee of a lower NZDUSD. Evidence around the majors (EURUSD, USDJPY) suggests interest rate differentials are no longer in the driving seat, and this chart says the same for NZDUSD.
NZDUSD six monthly chart
And if that’s not enough to keep the embattled Wheeler awake at night, NZDUSD makes up only 15% of New Zealand’s TWI, much less than NZDAUD, and the sharp rise in the NZD against the AUD in the last couple of weeks has been problematical.
If his colleague Glenn Stevens at the Reserve Bank of Australia cuts rates again in August – as per market pricing – that will be another spanner in the works.
So there are a lot of balls in the air.
New Zealand’s Reserve Bank governor is held personally responsible for meeting inflation targets, and while he may not be in any immediate danger of the axe in the manner as Louis Van Gaal at Manchester United, death by a thousand cuts may be his fate in the end as his political masters tire of excuses.
Unless, of course, Wheeler is lucky and “other teams”, like the US Fed or the RBA, play in a manner that results in a decent decline in the level of NZD, thereby saving him from the drop.
-- Edited by Adam Courtenay
Max McKegg is managing director of Technical Research Limited. If you would like an email notice each time Max posts a trade, then click here to follow him.