NZ needs a sustained period of currency weakness to help rebalance the economy, Cameron Bagrie reiterates.
The NZD/USD is sub 60 cents and on track for a possible nudge at 0.55. Back in 2023 and early 2024, the consensus was for a slow appreciation. We’ve seen the reverse.
Currency cycles are funny things. Currencies tend to overshoot and undershoot by more than you expect.
New Zealand’s currency credentials are not strong when you weigh up growth, productivity, a large current account deficit and China worries, and there is a real risk New Zealand receives a credit downgrade in 2025.
The USD/CNY has broken 7.3 with the “managed peg” being challenged, symptomatic of China’s problems – and NZ relies on China. Recall the pressure on the NZD in 1984 as decades of poor policy and economic management came to bear. Pressure on the USD/CNY has similarities.
A key side of the equation is the United States dollar. Uncertainty surrounding US foreign and trade policy has led to a depreciation in some currencies more sensitive to global trade and pushed the USD higher.
US inflation is also proving to be persistent, and markets continue to pare back expectations the US Federal Reserve will lower interest rates. The yield on a US 10-year bond has gone from 3.7% in September 2024 to 4.68% at the time of writing. That entices capital seeking yield.
Some of that also reflects rising risk premiums associated with government debt levels. US government debt levels are a concern, but not immediately pressing when they are seeing strong growth.
Key drivers, though, are inflation and growth. The annual core consumer price inflation rate in the US, which excludes items such as food and energy, came in at a three-month high of 3.3% in November 2024, unchanged from October and September. Prices for services excluding energy services, which are closely monitored by the Federal Reserve as a gauge of underlying inflation, slowed to 4.6% in November from 4.8% in October, but that level is still far too elevated.
The annual inflation rate in the US rose for a second month in a row to 2.7% in November 2024 from 2.6% in October. We await the December read which we will get in mid-January.
Inflation, according to the Fed’s preferred measure, the private consumption deflator, is well down from its mid-2022 peak of around 7%, coming in at 2.4% in November. That is still above the Fed’s 2% goal, and in December policymakers projected slower progress toward the target than they had earlier anticipated.
US services sector activity accelerated in December with a measure tracking input prices rising to a near two-year high. The US labour market is not rolling over either with unemployment 4.2%. New Zealand’s is set to rise above 5%.
It looks like progress getting inflation to 2% has stalled. Two Federal Reserve policymakers recently said they feel the US central bank’s job of taming inflation is not yet done. They should be fretting about tariff policy. With core inflation 3-3.5% and growth around 2-3%, the Fed Funds rate should be closer to 5.5% rather than the current level of 4.25-4.5%.
We cannot afford a costs shock. Goods deflation has been a key driver getting US and global inflation down. That could quickly turn positive at a time service sector inflation is elevated, if we see some sort of geo-political or geo-tech supply-side cost shock emerging in 2025. There is no shortage of candidates as the world fragments. We await more clarity on US tariff proposals and need to keep eyes on the brewing battle between the US and China over microchips.
The Federal Reserve’s 100 basis points of interest rate cuts since September have been met with a counterbalancing 100-basis-point rise in the 10-year Treasury yield. That move has partially flowed into other bond markets, including NZ where the yield on a 10-year bond has risen around 50 basis points since September 2024.
Where does this leave us? I’ve noted in recent currency focused articles that NZ needs a sustained period of currency weakness to help rebalance the economy. That view has not changed. There has been an alarming drop of exports as a share of gross domestic product. The scrum needs to be screwed in favour of exporters and the currency is a relative price variable helping with that process.
Strength in the US economy and the persistence of inflation is simply adding some icing on the cake for exporters with the move below 0.60. The US Federal Reserve has been very proactive cutting interest rates. That strategy contained risks because the inflation battle is not yet won. Markets have pulled back from anticipating further reductions in US interest rate for good reasons.
The US is not alone either. German inflation accelerated more than anticipated last month, when consumer prices rose 2.8% from a year ago in December, up from 2.4% in the previous month. German services inflation edged up to 4.1% from 4%.
Central banks need to remain alert.
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