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Currency direction a key to next year's election results?

Exchange rate movements are going to be the key to the performance of bond and equity markets over the next year.

Friday, October 3rd 2003, 7:51AM

by Anthony Quirk

This market summary is provided by Guardian Trust Funds Management. To see how the numbers stacked up for various markets around the world in the past month and over the year, visit our Monthly Market Review here

As foreshadowed in last month's commentary (Is a day of reckoning coming for the US dollar?) the market is now starting to adjust to the likelihood of US dollar weakness.

This developed through September to the point that we had the somewhat bizarre sight of the governments of each major currency block trying desperately to talk down the value of their respective currencies. The most blatant has been the Japanese authorities who have actively sold more than $135 billion of Yen since the start of the year, in an effort to help their export sector.

This is the same driving force behind the desire for the Euro to be weaker, likewise for the US dollar and we even had our own Minister of Finance joining in, attempting to "jaw bone" the kiwi dollar down. So much for the benefits of a strong currency!

In the case of the United States, President George W Bush is all too aware of the need to have greater job growth to improve his chances of being re-elected next year. The frustration for Bush is that the US is in the middle of an economic recovery but unemployment is remaining stubbornly high.

Part of the problem is that job creation is usually a lagging, not a leading, indicator. That is, rather than preceding a pick up in an economy, unemployment is usually one of the last factors to improve through a recovery. So far in this recovery new jobs are still not appearing – with economists debating whether this is simply delayed or may not arrive at all.

Chances are it is the former but the world economy could be in trouble if it is the latter. This is because strong job growth is a key factor in sustaining the US economic recovery through to next year as this will help fuel continued consumer spending – the engine room of the US economy.

So to aid the manufacturing sector the Bush administration seems to have commenced a "weak dollar" policy in an effort to overcome the perception that US jobs are being "exported" to China. Part of the problem, they believe, is that in pegging its currency to the US dollar the Chinese are too competitive for the average US manufacturer.

So why is this so important for the average New Zealander? Well, most commodities (such as dairy, wool and meat) are denominated in US dollars and any depreciation in the US dollar can mean a corresponding appreciation for the New Zealand dollar. If this occurs exporters who are already hurting may suffer even further, with a kiwi/US cross rate of well into the 60s now being a distinct possibility.

While currency hedging by some companies mitigates this factor there is no doubt that short, sharp shocks in currency can negatively impact on the export sector, which has little time to adjust to the new reality. Conversely, domestically oriented sectors such as retail, transport and building may benefit.

Traditionally a rise in the kiwi dollar provided the retail sector with windfall gains from being able to charge the public the same retail price but pay a lower wholesale price for overseas goods. However, competition has eroded this somewhat with much of the currency gain being passed on to consumers by way of lower prices.

Hopefully petrol prices will be one such example, although the oil price did gyrate through the month as OPEC announced some cuts to production, in anticipation of Iraqi oil production rising markedly over the next few months.

The domestic building sector could be helped by a high kiwi dollar as that may force New Zealand's Reserve Bank to lower interest rates – further fuelling an already "white hot" sector. If the Reserve Bank did not lower rates because of concerns about the building boom and the kiwi did rise to the mid 60s against the US dollar this could be the catalyst for a significant recession just around election time next year.

In terms of the numbers for September the New Zealand equity market continued to shine while bonds staged a comeback after a period of price weakness. The NZSX50 Index was up 3.0% for the month and is up almost 17% for the past year. Small companies have done even better with the NZSX Small Cap Index up 4.3% for the month and 22.7% for the past twelve months.

Overseas equity markets were down for the month with the NASDAQ falling 1.2% and the main US equity index, the S&P 500, down 1.1%. Even so this is the best September result for these markets in four years and both were in positive territory for the quarter, up 10.5% and 2.2% respectively. For the past year the numbers are even better with the NASDAQ up 52% and the S&P up 22%.

Japan has been the stand out equity market over the past quarter, being up 12.5% on the back of improved business sentiment and activity levels. The Tankan survey of sentiment amongst manufacturers rose to its highest level of the past three years.

On the bond side, in New Zealand the CSFB Government Bond Index was up 0.9% for the month although it is down 0.5% for the quarter. Global bonds did better, with the Lehmans Index up 2.1% for the month and 0.6% for the quarter.

From here, as discussed above, exchange rate movements will be a key determinant of bond and equity price movements as well as having a potential influence on the 2004 elections in the United States and New Zealand.

To see how the numbers stacked up for various markets around the world in the past month and over the year, visit our Monthly Market Reveiw here

Anthony Quirk is the managing director of Guardian Trust Funds Management

Anthony Quirk is the managing director of Guardian Trust Funds Management.

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