Dissecting what will lower US inflation

  • Local economic data is still irrelevant to the direction of the Kiwi Dollar
  • Currently, the main contributor to US inflation is about to reverse?

Local economic data is still irrelevant to the direction of the Kiwi Dollar

Last week, New Zealand’s better-than-expected June quarter GDP growth figure of +1.70% very briefly pushed the NZD/USD exchange rate up 20 pips, but it was soon pushed below 0.6000 by a further rise in the value of the US dollar. .

The previous week saw dairy prices rise for the first time in four months, in years past this would have pushed the Kiwi dollar higher as forex traders viewed dairy prices as a proxy indicator of the New Zealand economy. The Kiwi Dollar found no buying support from the dairy elevator as offshore traders have for more than two years dismissed the New Zealand currency as a trading opportunity. The evening of international interest rates at 0% during the period of the Covid pandemic and now that they are all around 3.00% (except Europe and China), the kiwi dollar offers no advantage , interest or opportunity for currency bettors. The GDT dairy auction this Wednesday morning will most likely see further price increases as European supply in export markets dwindles (due to their energy crisis), but don’t expect any gains of NZD accordingly.

Given the overwhelming evidence that New Zealand news releases and economic trends have absolutely no impact on the NZD/USD exchange rate (and haven’t for two years now), it is somewhat surprising and very strange that regular local bank foreign exchange reports never cover NZ factors in their NZ dollar commentary section.

The outlook for the New Zealand economy is subdued at best, given chronic labor shortages, higher mortgage interest rates, weak business investment and low levels of business and consumer confidence. consumers. However, that doesn’t mean the NZD dollar can’t recover from 0.6000 and move significantly higher when the US dollar turns around on the global stage. The credit rating agency Standard & Poor’s published a reasonably positive assessment of the New Zealand economy last week. They said our economy had performed better than others thanks to the Covid shock. A cynical response to the S&P report is that they only spoke to Treasury and RBNZ mandarins in Wellington, businessmen in the regions would have given them a different message!

The US Dollar’s gains against the EUR and AUD caused the NZD/USD rate to flirt further below 0.6000 to 0.5945 last Friday, but it recovered again to 0.6000. Ahead of the Fed meeting this week, currency markets will be watching US housing data with the NAHB index for September on Tuesday morning and permits/housing starts for August on Wednesday morning. The NAHB index is expected to decline further from 49 to 47. Weaker US housing numbers will not be positive for the USD, as the following analysis indicates.

Currently, the main contributor to US inflation is about to reverse?

On Thursday morning (6 a.m.) this week, we hear from the US Federal Reserve with a 0.75% increase in its official interest rate, dot-plot interest rate forecasts for 2023 from Fed governors and updated economic forecasts. Predictably, they will tell the markets and the world that US interest rates need to be kept higher for longer to bring down high inflation. All of this warmongering rhetoric is already fully integrated into the bond, equity and currency markets.

The following series of four charts suggests that the rapid tightening of US monetary policy over the past few months has already destroyed the US housing market and it is only a matter of time (within the next three or four months) before the consequences of their actions do not force the annual inflation rate to fall sharply. Bond, equity and currency markets should soon begin to price in the analysis below and assess the Fed as it nears the end of its tightening cycle, i.e. the work they had to done is done!

Chart 1: The rapid rise in US mortgage interest rates from 3.00% to over 6.00% over the past six months (red line, inverted right axis) has boosted confidence in the housing construction sector (blue line of the NAHB index, blue line on the left – axis of the hand) in free fall, with further declines very likely. The Fed’s monetary policy tightening is already having a massive negative impact on housing.

Chart 2: Historical correlations tell us that US home building permits (red line) and housing starts (green line) will follow the NAHB index (blue line) down sharply over the next few months.

Chart 3: The dramatic increase in US house prices (due to excessively accommodative Covid-related monetary policy in 2020 and 2021) has started to slow. The Case Shiller home price index (blue line) appears to have peaked and started to decline. The historical correlation of house prices with the NAHB index suggests that house price increases will quickly narrow to 0% from the current +18% (yellow arrow down).

Chart 4: Historical correlations and “cause and effect” also tell us that lower prices in the US inevitably lead to lower housing rents (US Sheter CPI, red line, right axis). What we do not know precisely is the time lag between the fall in property prices and the fall in rents. The Federal Reserve must know the expected lag and for this reason it should anticipate that the current rise in house rents (the current largest contributor to underlying inflation in the United States) is unsustainable and when it stabilizes , the annual inflation rate will decline as fast as possible. it rose from 3.0% to 8.5% in the first half of 2022. The Fed needs to look out the front window of the car, not the rearview mirror of economic data.

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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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