NZ DOLLAR FLYING HIGH AGAIN
Mark Lister, 8 March 2021
The NZ dollar has pushed through US$0.73 against the US dollar, which sees it at its highest level since early 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 last year, when the NZ dollar fell almost 20 per cent during the most fearful period of the pandemic.
That 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.
Interestingly, that saw US shares hold up better than the local market during the GFC in NZ dollar terms, despite domestic shares proving more defensive in a local currency sense.
Today, financial markets are in a much more upbeat mood. The vaccine programme is well underway, investors are focused on a gradual reopening of the global economy, and corporate earnings have begun growing again.
Not only that, but the local economy in also in very good shape. Despite the challenges we face, we are in an enviable position compared with many other parts of the world.
Our unemployment rate is lower than most, we have more fiscal headroom to continue supporting the economy and there are few virus-related restrictions in place.
Commodity prices also remain highly supportive, with the global dairy trade (GDT) index having risen at the last seven consecutive auctions. It is now up 22.3 per cent since the end of October and at its highest level since early 2014.
Dairy prices and the NZ dollar (at least against the greenback) enjoy a close relationship, which is illustrated in the chart below.
Global dairy prices and the NZD USD
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, Mainfreight or Pushpay.
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.
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 suggest the NZ dollar could rise to US$0.75 between now and June 2022, which would see it almost three per cent higher than current levels.
However, it should be noted that while the US dollar gets much of the attention, the moves against other currencies haven’t been nearly as strong.
In fact, the NZ dollar has fallen 6.9 per cent from its 12-month high of A$0.9950 against the Australian dollar, where it sat in March last year.
In contrast to the US, where the stronger currency has eroded most of the return over the past 12 months (from 16.8 per cent to 1.1 per cent for the S&P 500 index), a weakening NZ dollar against its Australian counterpart has added to returns from Australian equities.
There is every chance this continues, given the better relative position of the Australian economy, compared to many others. Like us, Australia is benefitting from strength in commodity prices and from a robust Chinese economy.
If global growth picks up as expected, the Australian dollar could find itself in vogue with global investors to a similar (or greater) degree than our own, which could insulate local investors from adverse currency moves.
The NZ dollar has also declined against the British pound, while it is little changed against the euro compared with where it was at the end of 2019, before the emergence of COVID-19.
A strong currency certainly isn’t all bad. Investors with a long-term horizon should cheer the prospect of getting more bang for their buck, and the ability to add more great international businesses to portfolios while the NZ dollar is relatively strong.
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.
As investors, these are all things we need to be mindful of, although currency moves 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 and whatever currency their shares happen to be priced in.
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.