Thursday, October 30, 2014

FOMC hawks make for strong US dollar | …and the Kiwi dives

While we did not have any insight into the strongly hawkish statement that was issued by the Federal Open Market Committee (FOMC) last evening beyond an expectation of what was well telegraphed, namely the discontinuation of Quantitative Easing (QE) in the US, we did intimate that the New Zealand central bank would [NZ dollar (Kiwi) is back in focus], in its monetary policy statement and interest rate decision, move to depress the New Zealand currency.

The FOMC has significantly changed its stance on what is perhaps the most important factor in its decision making, the labour market. It said that “on balance, a range of labour market indicators suggests that underutilisation of labour resources is gradually diminishing”. So they see a possible end of the so-called slack in the economy. It also sees less of a threat from disinflation and even low inflation. It said that “The Committee judges that the likelihood of inflation running at persistently below 2% has diminished somewhat since early this year”.

All of this together with the formal ending of QE has strengthened the US dollar against all its major counterparts. The next influence on this tendency will come with the announcement of the Non-farm Payrolls report at the end of next week. A strong jobs report trend would presage an early rise in US interest rates.

…and the Kiwi dives

As expected, the Reserve Bank of New Zealand (RBNZ) left its core interest rate unchanged in its announcement some short time after the FOMC statement. It talked about low commodity prices taking the pressure off the currency but reiterated that, in its opinion, the current exchange rate for the New Zealand dollar was unjustified, unsustainable and constrains growth. It expects further significant depreciation.

Inflation, according to the central bank, remains modest at 1% per annum. This is mainly driven, as elsewhere, by low energy prices, but is expected to increase.

Lastly, it said that a period of assessment remains appropriate before considering further policy adjustments. This is code for saying that no interest rate rises are on the cards for the foreseeable future. In the meantime is said that the macro prudential policies it had initiated to curb property lending were successful. This means there is no pressure to raise rates to combat a property bubble.

As seen in the chart at the top, the Kiwi reacted appropriately by tumbling against the US dollar.

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