Summary of key points: –
- Stronger than expected Non-Farm Payrolls delays the Fed’s next interest rate cut
- Australia is a likely destination for equity funds exiting the US market
- The pendulum swings against further RBNZ interest rate cuts
Stronger than expected Non-Farm Payrolls delays the Fed’s next interest rate cut
The condition, trend and outlook for employment levels in the US economy plays a vital part in determining monetary policy settings by the Federal Reserve. Under their dual mandate to maintain strong employment and low/stable inflation, the Fed applies different weights to each objective depending on where they are in the respective cycles. Both employment and inflation influences need to be constantly examined to gauge what the Fed’s next step will be.
Actual reported annual inflation is now very close to the Fed’s target of 2.00%, however they have been “on hold” for more than six months now in terms of cutting interest rates to ease monetary policy. They continue to state that they do not yet have clarity on how much Trump’s import tariffs will increase US inflation later this year and into next. Latest reports from the White House indicate that President Trump is keen to wrap up trade deals and settle tariff percentages sooner rather than later. Preliminary agreements have been struck with the UK, China and Vietnam, with many details still to be finalised. Hopefully, the Fed will have sufficient information on tariff levels over the next few weeks to calculate the impact on future inflation. They will need calibrate the inflation on imported goods against the continuing reductions in rents/housing costs that dominate the CPI weightings.
In respect to the employment side of their remit, there are three principal measures the Fed monitors to ascertain the strength of the labour/employment market: –
- Non-Farm Payrolls (survey of employer’s hiring and firings): The June jobs increase released last week of 147,000 was considerably stronger than the +100,000 prior forecasts. The trend of US employment over recent months from this measure would suggest a stable environment with some question marks over the massive increases reported in November and December last year (refer first chart below). The Non-Farm Payroll data is notoriously prone to subsequent large revisions in the initially reported job increases, mostly downwards.
- Household Labour Force Survey: Determines the unemployment rate, which has been very stable at 4.10% to 4.20% over the last 12 months. In June, the number employed by this measure increased by a modest 93,000, however the overall labour force shrank by 130,000 (illegal workers being deported).
- ADP Employment Change (survey of private sector jobs, excludes Government): Private businesses shed 33,000 jobs in the month of June according to this measure, the first decline since March 2023. The US service sector lost 66,000 jobs in June. The second chart below confirms the consistent decline in jobs over the last eight months due to tariff uncertainties since Trump came to power.
Which employment statistic is the more accurate measure of labour market conditions in the US economy?
The Non-Farm Payrolls measure is generally considered a more comprehensive measure of employment trends. However, the June increase of 147,000 was dominated by a 73,000 increase in Government jobs (state employees and teachers) and a 39,000 increase in the healthcare sector (as always). The Government sector job increases are unlikely to be recurring and are not a good indicator of overall demand and supply in the economy.
The interest rate markets in the US were pricing in a 25% probability of a 0.25% cut at the 30th July Fed meeting, however that dropped to below 5% probability following the June Non-Farm Payrolls release last week. Market pricing is now at a 65% probability of a 0.25% cut in the September Fed meeting. The US dollar did not really gain on the stronger than expected jobs numbers and remains under downward pressure at the 96.65 level on the USD Dixy Index. Employment statistics always lag general economic direction and are therefore not a reliable lead-indicator. If the Fed are now looking forward on expected future inflation impacts (tariffs), they should also be examining the forward-looking employment surveys as well. The ISM Manufacturing Employment sub-component survey for June, also released last week, was particularly weak at 45.0 compared to prior forecasts of 48.0. The ISM Services Employment sub-component was also much softer than anticipated at 47.2 (51.1 forecast). The Fed would be unwise to interpret the labour market as currently “stable”, even though the unemployment rate is very stable at 4.10%.
Australia is a likely destination for equity funds exiting the US market
If you were a global equities fund manager sitting in London or Luxemburg, where would you re-allocate the funds that are now available for redeployment from exiting the US market?
In searching around the global for good entry opportunities, these investment funds will be analysing both relative equities market performances and relative foreign exchange performances. The Australian equities market and the Australian dollar value would have to be considered strong candidates to meet the criteria of a relatively undervalued share market (vis-vis the US equities market) and undervalued currency level.
The following two charts confirm just how much the Australian equities market has lagged the performances of both the US and European equities markets, particularly since early 2024.
It appears compelling to be entering the Australian equities market, even though the banking stocks may already be fully valued. The smart money may be looking to switch into Australia before the Aussie dollar makes further gains against the depreciating US dollar. Like the Kiwi dollar, the Aussie has been held back from stronger advances against the US dollar (compared to the Euro’s performance over recent months) due to the heavy reliance on the Chinese economy. Those concerns about tariffs adversely impacting the Chinese economy still seem overrated in our view. The Chinese economy is slowly recovering from its property market woes and will expand by their target growth rate of 5.00% this year.
Based on the expectation of global equity fund managers adjusting their money to higher Australian market weights, the resultant capital flows into Australia point to sustained appreciation of the Australian dollar. It looks reasonably certain that the Reserve Bank of Australia will cut their OCR interest rate from 3.85% to 3.60% this Tuesday 8th July. We do not see these interest rate reductions as being negative for the Aussie dollar value. Over the balance of this year, three or four x 0.25% interest rate cuts by the RBA are more than likely to be matched by the Fed doing the same amount in the US.
What stands out as being potentially hugely positive for the Australian dollar over coming weeks, is the short-sold AUD speculative positioning in the US futures markets. The currency punters are no longer short-sold the NZ dollar, however the Aussie dollar remains at 70,000 contracts short sold, anticipating AUD depreciation. These speculators are likely to be “stopped out” of their positions as the AUD makes further gains to the USD above 0.6600 (currently 0.6560). The punters will need to buy the AUD to close down their short-sold positions.
The pendulum swings against further RBNZ interest rate cuts
It was only a matter of a few short weeks ago that the local bank economist fraternity were confidently predicting the RBNZ dropping the OCR interest rate to 2.50% to aid the perceived weak economy. The economist’s forecasts and interest rate market pricing has now shifted towards 3.00% being the terminal OCR interest rate on this easing cycle. Stronger GDP growth and higher inflation at this time than what the RBNZ were forecasting at their 28th May Monetary Policy Statement will be behind a decision this Wednesday 9th July to leave the OCR unchanged at 3.25%. There is no question that the export-led economic recovery is stronger than what most anticipated and on the other side the domestic housing and retail sectors are taking longer to pick up from the impetus of a 2.25% reduction in interest rates over the last 10 months.
The likely offshore currency market reaction to a signal from the RBNZ that they are at the end, or very near to the end, of their monetary policy easing cycle will be a positive factor for the Kiwi dollar in its own right.
Business confidence trends in New Zealand (as a proxy for relative economic performance) were highly correlated with NZD/USD exchange rate movements up until three years ago (refer to the chart below). Whilst business confidence has recoiled from the record highs a little bit in recent months, there remains an enormous gap to the undervalued NZ dollar value. US interest rates being well above those in New Zealand over the last 12 months has restricted the Kiwi dollar making further advances against a depreciating US dollar. Looking ahead, NZ interest rates going no lower and the potential for the Fed to cut US interest rates by over 1.00% over the next six months, closes up the impediment of the interest rate differential.
The elevated business confidence levels point to an expectation of the New Zealand economy outperforming others in the relative GDP growth stakes. On top of the fantastic export commodity prices and lower interest rates, the NZ Government’s accelerated depreciation stimulus to domestic business investment stands as a key driver of the strong GDP growth of over 3.00% for 2025.
It is only a matter of time before global currency investors recognise the opportunity and start buying the Kiwi dollar as a diversification away from the beleaguered US dollar.
Select chart tabs
*Roger J Kerr is Executive Chairman of Barrington Treasury Services NZ Limited. He has written commentaries on the NZ dollar since 1981.