Kiwis Still on the Menu?
[Update Added Below x 2]
Well, it could certainly seem so after today's inflation figures which beat the central bank's expectations. It is of course still too early to say anything but with today's inflation data the markets are gearing up for the RBNZ to raise the refi rate to an unprecedented 8.25% next week. In doing so the bank will clearly be playing into the hands of all those savvy retail investors and indeed institutional players playing the carry trade which is driven by very high global capital mobility and high interest rate differentials between central banks.
Here is a quick summarizing quote from the FT ... (linked above)
Non-tradable, or domestic, inflation - which excludes import prices - rose 1.1 per cent on the previous quarter and 4.1 per cent on year. That compares with 1.2 per cent on quarter and 4.1 per cent on year in the first quarter. New Zealand’s interest rates are already at 8 per cent, the highest in the industrialised world, fuelling a rise in the New Zealand dollar driven by yield-hungry investors. Economists now believe the bank will probably need to raise interest rates to a new record of 8.25 per cent next week in order to stem the rise in inflation. ”It’s very strong and strong in all the wrong places from the (Reserve Bank’s) point of view,” Nick Tuffley, chief economist at the ASB Bank in Auckland, told local media. ”This has raised the odds of an interest rate increase,” he said.
Eight of 14 analysts surveyed by Bloomberg expect the official cash rate to be raised by a quarter percentage point on July 26. Strong appetite for carry trades, in which low-yielding currencies are sold to fund the purchase of higher yielding currencies, has driven the kiwi dollar to record levels. The Reserve Bank of New Zealand in June took the unprecedented step of intervening in the currency market to try to stem a rally that had seen the kiwi dollar rise to its highest level since being floated in 1985.
As you may remember and as the FT also notes it was not too long ago that the RBNZ actually intervened in the FX market in order to halt the appreciation of the currency. From a text book perspective this is probably making many an econ 1-0-1 student (or perhaps their professors?) a wee bit weary about what the textbook tells them since a central bank presiding over a rather large and growing current account deficit shouldn't exactly be in the market to depreciate its currency, now should it? Well, this is the nature of the current interest differential yield game being played world wide and as we can see it is already becoming something of a test of minds between market participants and policy makers in the central banks. If the inflows themselves are what is, in part, fuelling the inflation then of course raising rates might not do trick, on the contrary (are you listening in Frankfurt?). My guess is that it would be a good idea to keep a weather eye on those high yielding currencies and their respective central banks; especially if the ECB stops its hiking campaign sometime in the latter part of 2007 those CBs still having the courage to look north will be in for a turret ride I think.
'It seems to me that the prospect of the currency of one of the world's largest and most populous economies(Japan) being dumped for the currency of one of the world's smaller and more isolated economies is somewhat Kafka-esque.
A quick review of the Wikipedia entry on New Zealand shows NZ to be "a country heavily dependent on trade, particularly in agricultural products, and exports almost 28% of its output." Thus, the current carry trade situation looks to be particularly damaging to NZ's economic prospects.
As far as long term solutions for New Zealand go, the Wikipedia authors state that "the current government's economic objectives are centred on pursuing free-trade agreements and building a "knowledge economy". In 2004, the government began discussing a free trade agreement with the People's Republic of China, one of the first countries to do so. Ongoing economic challenges for New Zealand include a current account deficit of 9% of GDP, slow development of non-commodity exports and tepid growth of labour productivity. New Zealand has experienced a series of "brain drains" since the 1970s as well educated youth left permanently for Australia, Britain or the United States." With a population of only 4.2 million and a below-replacement total fertility rate of 1.79, it seems to me that New Zealand likely lacks the human capital to generate sustained economic growth. Given the country's geographic remoteness, it seems unlikely to attract skilled immigrants in any meaningful numbers.
It seems that New Zealand's situation today is analogous to the Eastern European countries being discussed over at Demography Matters.
The always readable Andy Mukherjee chimes in on the carry trade flurry in Asia with the focus on the Singapore Dollar as a potential vehicle for funding the low risk part of a carry trade.
Carry traders in Asia, having survived the initial jitters from the U.S. subprime-mortgage crisis, are now looking for funding currencies with less risk.
While the Japanese yen and the Taiwanese dollar remain the vehicles of choice for financing purchases of the New Zealand dollar and other high-yielding currencies, the risk of a reversal in these trades is prompting the search for alternatives.
The cost of money in Taiwan is rising, partly because the central bank wants to kill the carry trade and arrest capital outflows. Although the yen remains very much in play, no one knows for how long. The Bank of Japan may signal higher interest rates as early as next month. And that makes funding positions in yen very profitable, but dangerous.
Amid these threats, the Singapore dollar may fit the bill nicely as a low-risk funding currency.