Summary of key points:-

  • Is US inflation peaking? – the bond market can provide the answer
  • New Zealand’s upcoming budget and monetary statements are set to be ‘totally disappointing’
  • US consumer confidence has plummeted – will the value of the US dollar follow?

Is US inflation peaking? – the bond market can provide the answer

Concentrated buying of US dollars against all major currencies on Friday May 13, following the slightly higher than expected US inflation figure for April, pushed the Kiwi dollar to a two-year low at 0.6215 .

U.S. inflation trends remain the dominant influence on the direction of all global financial and investment markets today, as the Fed’s responses with monetary tightening drive decision-making. everywhere.

While the US Headline Inflation reading for April at +0.30% was only marginally above the consensus forecast of +0.20% with lower energy prices , the measure of “core” inflation (excluding energy and food prices) rose 0.60%, enough above the +0.40% should excite the markets that the Fed has still a lot to do.

However, the wholesale producer price index (“PPI”) in the United States the next day indicated that some of the supply chain pressures could peak, as the increase in the basic PPI was lower. to previous forecasts.

The reaction of the US Treasuries market to these latest inflation indicators has been instructive. Long-term interest rates (10-year bond yields) actually fell from a high of 3.20% on May 9 to a low of 2.82% on Friday May 13. The dramatic increase in 10-year bond yields, from 1.50% at the end of January to 3.20% last week, reflected the markets’ lack of confidence in the Fed’s ability to fight rising inflation, as well as the fact that the Fed itself has now become a big seller of bonds as they reduce the size of their balance sheets (part of the reversal of monetary policy from easing to tight). The shift in sentiment and direction in the bond market may just be profit taking by speculative players, or it may represent a more fundamental belief on the part of large fixed rate fund managers than sharp increases in US inflation over the past few months now subside.

There is clear evidence in historical and current inflation figures that the annual increase in US inflation over the next few months will begin to decline from the peak of 8.50% recorded for the year through March. . The two biggest contributors to the April 2022 inflation increases were housing and air fares. Repeated increases in both of these prices over the next few months seem unlikely as lumber and oil prices decline and airlines’ supply capacity increases. The large increases in used car and new car prices 12 months ago (in May and June 2021) coming out of the annual measure will help the annual inflation rate to come down from here. The annual core inflation rate in the United States could come down to 6.00% fairly quickly over the next few months. Still well above the Fed’s tolerance limit for inflation, but at least in the right direction. If other US economic data looks weaker over the next few weeks, the bond market will conclude that US inflation has peaked and bond yields will fall, not more.

The bond market advance will also have implications for equity and currency markets:-

  • US stock markets rebounded 1.50% on Friday May 13 following the PPI figures, the first sign of buying interest after eight straight days of selling. Falling bond yields are positive for tech stock valuations.
  • The US Dollar Currency Index reversed from highs of 105.00 to 104.50. The AUD/USD exchange rate reversed higher to 0.6940 from a low of 0.6830. Further gains for the AUD look likely once the political risk/uncertainty subsides after next Saturday’s election.

The surge in the bullish US dollar since February, when the Russian-Ukrainian war pushed oil prices and US inflation higher than currency markets had previously expected, may finally be running out.

As global bond, equity and currency markets recalibrate over the coming weeks to the fact that US inflation has already peaked, the NZD/USD and AUD/USD exchange rates will finally have the opportunity to recover a good part of their sale of seven cents. -off for the past six weeks. It should be remembered that the recent selling of NZD and AUD is not permanent capital out of our markets, but simply a short-term speculative positioning in the forex market based on selling all currencies against the dollar rampant american. Given the greater likelihood that offshore US Dollar sentiment and direction will reverse over the coming months, local USD exporters should be hedged forward to the maximum policy limits (and beyond!), While USD importers can wait and wait for a return above 0.6800.

New Zealand’s upcoming budget and monetary statements set to be ‘totally disappointing’

Grant Robertson’s Thursday May 19 fiscal statement and Adrian Orr’s Wednesday May 25 monetary statement have an opportunity to offer policy that will solve the biggest problem New Zealand currently faces, the rising cost of life.

Don’t hold your breath they will be bold and innovative in providing solutions to time-pressed household finances. Instead, be prepared for a budget statement from the government about redistributing a shrinking pie, not growing the pie. As well as stoking the fire of inflation with increased budget spending, the budget will revamp the lounge chairs in the health sector and (as always) be dominated by the talk of climate change.

The RBNZ is also expected to disappoint by offering a tighter monetary policy framework after the latest statement in February achieved the opposite of what it wanted as the depreciation of the New Zealand dollar eased monetary conditions instead of tightening them. The RBNZ needs to drop the comments as if to raise the OCR by 0.50% in order to have the option to cut interest rates later when the economy turns to custard.

Both statements should address the ‘elephant in the room’ of our bloated bureaucracy to administer excessive regulation resulting in continuously rising costs for households and businesses. Both statements will unfortunately fail to do so.

None of these statements will have any impact on the NZD/USD exchange rate. Over the next week, Australian earnings data for Wednesday May 18 is more likely to influence the NZD/USD rate (tracking the AUD/USD rate) if the annual increase is well above 2.50% expected.

Additionally, pending announcements from the Chinese authorities on massive fiscal and monetary stimulus packages for their economy are likely to be much more important for NZD and AUD currency values ​​over the medium term.

US consumer confidence has plummeted – will the value of the US dollar follow?

The chart below tells the historical story that when US consumers are dissatisfied and cut back on spending, the US economy does not fare so well, and a lower value of the US dollar reflects this economic underperformance ( for example, 2011). On the other hand, when consumers are happy and spending, the US economy outperforms and the USD appreciates (eg 2015/2016). The appreciation of the U.S. dollar over the past 12 months has been extended in magnitude and timing due to the Russian-Ukrainian war which has raised U.S. inflation much further than the Fed and equity markets had expected. changes.

The divergence of the two series has been extreme lately, the conclusion must be that the US Dollar is living on borrowed time!

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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.