Mark Fowler: Political backdrop driving financial narrative

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Opinion

I've highlighted in some of my earlier columns a belief that with the domestic economy remaining steady, some near term headwinds are likely to mean our economy's growth will hold above potential.

While there's definite cause to remain positive around the New Zealand economic story, some challenges have recently emerged which could stand to change that - including an undoubted slowing in residential property as well as credit growth moderating.

So, what could these factors mean for the Kiwi dollar?

Fundamentally, what drives the strength of currencies is interest rate differentials - being the difference in interest rates between two, similar interest-bearing assets. In this case, between New Zealand versus overseas currencies.

A recent lack of inflationary pressure has seen the Reserve Bank of New Zealand (RBNZ) indicate it will be sitting on the side-lines for an extended period, and won't be raising interest rates any time soon.

When compared with evolving outlooks for other major central banks, however, this has the undesirable effect of eroding New Zealand's relative yield advantage - at a time when the bias would otherwise tend towards potential for near-record high New Zealand terms of trade.

Our uncertain political backdrop is undoubtedly driving the financial narrative at the moment. While changing Governments don't usually have a sustained influence over the performance of the NZD, the make-up of the next Government may affect perceptions about the domestic growth outlook.

A continuation of the status quo - if the National party is to remain in power - would likely be viewed positively by foreign exchange markets, and therefore the NZD's medium-term trajectory shouldn't change.

The implications of NZ First's involvement should remain a focus. This is particularly true given its push for tighter immigration, and the subsequent potential negative flow-through on growth, as well as the potential impact of the party's protectionist stance on foreign ownership of New Zealand assets. Economically, the outlook for immigration is pivotal. New Zealand is a small, open economy which directly benefits from offshore capital, and in recent years strong net migration has boosted New Zealand GDP, with annual growth on a per capita basis less positive.

By contrast, the uncertainty stemming from a Labour, Greens and NZ First coalition could be perceived negatively - generating a more pronounced NZD reaction, particularly if we were to see this offshore capital disappear.

Although Labour's fiscal policy stance is expansionary, markets appear set to remain focused on the push by Labour and NZ First to stem immigration, albeit to differing degrees - restricting non-resident property ownership and possibly changing the RBNZ's monetary policy framework.

Any attempt to pick the direction of the currency is always a challenging task - but in light of these recent trends, the NZD's reaction looks likely to be skewed downwards.

The NZD has already weakened in recent months, exacerbated by key relative fundamentals having also moved against it - and now with political uncertainty creating an added headwind.

While we should gain some degree of political clarity this week, even a relief rally on a National-led government may be short-lived considering the subtle shift in the domestic economy, relative to where we are in the economic cycle.

- Mark Fowler is Head of Portfolio Strategy Group & Fixed Income at Hobson Wealth Partners Ltd.

The views expressed in this article are those of Hobson Wealth Partners Limited, an NZX Firm. The disclosure statement for Hobson Wealth is available free of charge by contacting us on 0800 742 737. This article does not consider objectives or situation of any particular investor. It should not be construed as a solicitation to buy or sell any security or product, or to engage in or refrain from engaging in any transaction. We recommend that you consider the appropriateness of information to your situation and obtain financial, legal and taxation advice before making any financial investment decision.