WHY A STRONG NZ DOLLAR MIGHT BE HERE TO STAY
Mark Lister, 26 November 2020
A few days ago, the NZ dollar pushed through US$0.70 against the US dollar for the first time since June 2018.
This strength in our currency isn’t a great surprise, and there’s every chance it will continue. This will have implications - both good and bad - for the economy as well as investors.
The US dollar, like the Swiss franc and the Japanese yen, is generally considered to be counter-cyclical.
In other words, these are the safe currencies that investors flock to when they smell trouble, but which fall out of favour when confidence is high.
In contrast, the NZ dollar, along with its Australian counterpart, is seen as a ‘risk currency’.
For a range of reasons, including the sensitivity of both country’s to commodity prices, our currencies tend to fly high when people are optimistic and get sold off when markets turn cautious.
We saw that happen earlier this year, when the NZ dollar fell almost 20 per cent during the most fearful period of the pandemic.
This was also the case was during the GFC. The NZ dollar was trading above US$0.81 in the middle of 2007 and by early 2009 it had fallen to just below US$0.49, a collapse of almost 40 per cent.
Today, financial markets are in a much more upbeat mood. Numerous companies are making progress on vaccines, the US election is behind us and investors are focused on a gradual reopening of the global economy over the next year or two.
Not only that, but the local economy in also in relatively good shape. Despite the challenges we face, we are in an enviable position compared with many other parts of the world.
Prices for many of our export commodities are solid, our unemployment rate is lower than most, we have more fiscal headroom to continue supporting the economy and there are no virus-related restrictions in place.
This suggests the current dynamic is unlikely to change anytime soon, and whether this is good or bad depends on your perspective.
A higher NZ dollar means we are wealthier in a global sense, and that we have greater buying power across international markets.
That means all the products we purchase from overseas are cheaper, including imported components for products, most notably fuel.
This should keep downward pressure on interest rates, as it means that consumer inflation remains subdued.
On the other hand, many exporters would prefer a lower currency, as this makes their products more competitive and adds to returns.
For investors, a stronger NZ dollar can be a headwind for many listed exporters, such as Fisher & Paykel Healthcare and Mainfreight.
Having said that, if the conditions are in place for a strong NZ dollar one would think these companies are benefitting from the underlying economic backdrop in many ways too.
A strong currency also has a large impact on the international holdings of domestic share investors. As an example, if Apple shares are rising but the US dollar is falling, a local holder of Apple wins on the one hand but loses on the other.
That certainly doesn’t mean we should be put off investing outside our shores. As an example, 40 per cent of the revenue of companies in the S&P 500 comes from outside the US. For the technology, materials and consumer staples sectors, the proportions are even higher.
This means a weaker US dollar leads to higher profitability for many of these companies, which should have a positive effect on share prices and offset the currency headwinds for investors.
For those who long for a weaker currency, it seems we can’t have our cake and eat it too. If the outlook is positive the NZ dollar usually rises to reflect that, and if the currency is weak, it probably goes hand in hand with a more concerning economic picture.
It’s difficult to predict where the currency is going over the next few years, but if markets remain in a positive mindset and the local economy continues to perform better than most, it could push higher.
For what it’s worth, forecasts from the local bank economists over the next two years suggest the NZ dollar could end up in the low 70s against the US dollar, about three or four per cent higher than current levels.
As investors, that’s something we need to be mindful of, although it certainly shouldn’t drive our investment decisions. It’s more important to focus on great businesses with strong growth prospects, wherever they happen to be.
We should also remember that should trouble emerge, the winds could change quickly. We’ve seen that happen many a time in the past, and in those instances hedging our bets with a bit of exposure to other currencies has paid off.