Fed hardly hawkish but financial markets pay heed to chairwoman’s comments in relation to job growth.

Exporters can only hope that the economic news out of the United States this week will reinforce, or at least not reverse, the New Zealand dollar exchange rate's recent descent from eye-watering heights.

At the time of writing markets are awaiting the results of the Federal Reserve's deliberations on the outlook for US monetary policy, and data on June quarter economic growth and the state of the US labour market.

While we tend to focus on what we hear from the Reserve Bank or more recently Fonterra, no less important to the kiwi dollar's recent decline have been the comments of Fed chairwoman Janet Yellen and the US data flow, which pushed the US dollar to near six-month highs by the start of this week.

The International Monetary Fund's report on the state of the US economy earlier this month was pretty upbeat.


After a shocker of a March quarter in which activity contracted, it has rebounded and is heading towards annual growth rates around 3 per cent for the next three years, the IMF forecasts.

It could not sustain that pace indefinitely, based on fundamental capacity factors like labour force and productivity growth, but there is still enough slack in the economy for it to pose little threat to the Fed's 2 per cent inflation target any time soon.

The Fed has a dual mandate, employment as well as price stability.

The US economy created more than a million jobs in the first half of the year, pulling the unemployment rate down to 6.1 per cent, only fractionally higher than our 6 per cent.

But the labour force participation rate, which measures the proportion of working age people either employed or actively seeking work, is just 62.8 per cent, its lowest since 1987, while New Zealand's is 69.3 per cent, a record high.

And around 4.5 per cent of the American workforce are still involuntarily working part-time, the IMF says.

Pulling all that together the IMF reckons it will take three to four years for the slack in the US labour market to be taken up.

The output gap - how much less the US economy actually produces than its potential or sustainable output - is close to 4 per cent and will take until 2018 to close, it says.

When it comes to interest rate settings, that is a crucial difference from the situation in New Zealand where the Reserve Bank estimates the output gap will be positive, that is on the inflationary side, over the next three years.

It needs to be borne in mind if we hear the word "hawkish" used to describe US economic news this week.

That would only be valid to describe in binary terms the direction of change. In terms of levels it could only mean a bit less dovish. While the Fed is expected to complete the phasing out of its programme of quantitative easing by around next October, it will be some time next year before any increase in its policy interest rate from effectively zero now is on the cards.

When she appeared before the Senate banking committee a couple of weeks ago Janet Yellen said the federal open market committee which sets US monetary policy expected the current target range for the federal funds rate (0 to 0.25 per cent) was likely to be appropriate "for a considerable period" after the Fed's asset purchase programme (QE) ended, especially if projected inflation continued to run below its 2 per cent longer-run goal.

"In addition we currently anticipate that even after employment and inflation are near mandate-consistent levels, economic conditions may for some time warrant keeping the federal funds rate below levels the committee views as normal in the longer run," she said.

It is hard to discern the blood-curdling screech of the hawk there.

But the financial markets focused instead on what she went on to say, to the effect that interest rates would be likely to rise sooner and more rapidly if the labour market continued to improve more quickly than the Fed anticipated.

Hence the interest in tomorrow's jobs data. A Reuters poll of economists found they expect US employers to have added 233,000 jobs in July. Closer to home, ASB's economists expect it to be the second half of next year before we see the Federal Reserve raising the fed funds rate.

By then the Reserve Bank will have resumed the tightening it began in March but on which it has hit the pause button.

"The Reserve Bank is about halfway through its tightening cycle and we expect it will finish in the second half of next year. By that point other countries will be either lifting interest rates themselves or be very close to it, reducing the yield advantage of NZ dollar-denominated assets," ASB says in the quarterly economic forecasts it released this week.

"Our forecasts include some mild US dollar strength as US [interest] rates lift over 2015, but no significant US dollar strength until 2016. It means that in the absence of an unexpected shock, the New Zealand dollar is likely to trade largely above US80c over 2014/15." ANZ economists say the Reserve Bank might have put intervention in the foreign exchange market on the table in its comments last week.

"But they are swimming against a huge tide of portfolio inflows and yield advantage, hence the significance that broader US dollar direction takes on from here." ANZ expects the Fed to kick off interest rate rises next March.

Westpac expects the kiwi dollar to drop to US84c in the weeks ahead, and is forecasting an average exchange rate of US83c over the remainder of 2014.