INSIGHTS

The NZ dollar staged a major rebound late last year, with the trade weighted index having rallied five per cent in the final three months of 2019. It has remained resilient through the first few weeks of January as well.

One explanation is that our prospects simply look brighter than they did six months ago. Among other things, currencies reflect growth prospects, stability, and the return one can receive on their capital. In this regard, we look better than most.

However, much of this NZ dollar strength has come against the US dollar, which has declined against most global currencies, not just ours.

The US dollar rallied more than 40 per cent between 2011 and 2017, as the US economy picked itself up off the floor and the Federal Reserve pared back its quantitative easing programmes.

Since then, it’s struggled to push through those levels and in recent months it seems to have found itself on the back foot again.

The US economy is still very buoyant, with the American consumer in good spirits and unemployment at a 50-year low.

Those factors point to a strong currency, but in contrast you’ve got very little inflation, worsening deficits, election year uncertainty and a Fed that has become very reluctant to act for fear of derailing the expansion.

At the same time, there are improving signs in other parts of the world, which has seen traders refocus their attention elsewhere.

Europe is becoming more in vogue with investors after a long period of underperformance, the British pound has received a bit more attention with the path to Brexit looking clearer, and markets elsewhere are feeling more upbeat as trade tensions subside.

When sentiment is high like this, the US dollar often performs poorly as investors prefer cyclical currencies that are more sensitive to growth, including the New Zealand and Australian dollar.

When nervousness creeps in, the opposite happens. Investors dump these higher-risk currencies in favour of the safer US dollar, and the likes of the Swiss franc and Japanese yen.

This current dynamic is a double-edged sword for us. A higher exchange rate means our money goes further on the global stage, making us a wealthier nation. Imports more affordable, so inflation is kept in check and the Reserve Bank is inclined to keep interest rates nice and low.

Exporters are never as enthusiastic about a strong NZ dollar, as they become less competitive. Then again, commodity prices tend to rise when the US dollar is weak, so there has traditionally been a natural offset for farmers.

New Zealand companies with large US customer bases could face greater headwinds, if only from an earnings translation perspective. Fisher & Paykel Healthcare, Pushpay and Tourism Holdings are a few NZX-listed examples that spring to mind.

In terms of global shares, a weaker US dollar would have the opposite effect on American multinationals, providing them a healthy tailwind. Almost 40 per cent of total S&P 500 revenues come from outside the US, with international exposures even higher for the technology, materials and consumer staples sectors.

Longer-term, our exchange rate probably doesn’t deserve be as high as it is, and the US dollar should continue to provide a good hedge against any market turbulence that might emerge.

However, if the current optimism surrounding financial markets proves justified, the greenback might struggle to regain the momentum it had a year or two ago.