Roger Kerr posted on August 28, 2011 15:41
It is unlikely that both NZ short-term and long-term interest rates will move any lower from the current levels (one year swaps at 3.25% and 10 years at 4.85%), however when and how fast they move upwards is the debate that is exercising the minds of borrowers and investors alike.
If you are a true believer in the “global double-dip recession” scenario you might see rates lower from here, but I am ruling that out as an even low-probability scenario. Alan Bollard will be returning from the Jackson Hole central banker’s pow-wow with lower global growth and NZ currency/export commodity price divergence on his mind. Both factors suggest lower GDP growth for us in 2012 and thus lower inflationary risks i.e. interest rates at the current low levels for longer. It would be very unwise for Alan to look backwards at the stronger than anticipated (except by us) domestic economic data over the last nine months and conclude that he should keep the same upbeat tone in the 15 September Monetary Policy Statement (“MPS”) as what he had in the June statement.
The RBNZ MPS statement on 15 September has the capability to be considerably more “dovish” on the economic outlook than what the market anticipates. Many economists fail to comprehend the dominant impact the NZD/USD exchange rate has on GDP growth in New Zealand. Let’s hope the RBNZ economists don’t miss this connection. As we have seen from business lobby groups like the Winegrowers Association recently, the prolonged strength of the NZD above 0.8000 is doing a lot of damage to exporter profits, investment and jobs. Based on historical relationships the Kiwi dollar above 0.8000 suggests annual GDP growth will head back to negative over the next 18 months. The outlook for the NZ economy has changed dramatically over recent weeks with the currency and export prices diverging.
The other matter that will be weighing on Alan’s mind as he drafts the MPS is the sharp increase in bank credit margins as a result of recent turmoil in global financial and investment markets. European banks are under capital pressure and their credit standing is deteriorating. Australasian banks borrow part of their funding requirements form European debt capital markets and investors in those markets are demanding much higher credit premiums. Increased cost of funds for the banks (from both offshore and onshore retail sources) adds to the equation to leave the OCR lower for longer (at this stage).
Given this outlook for interest rates and the current low nominal rates available, Mum and Dad retail investors will most likely swamp the current Air New Zealand $150 million corporate bond offering. In normal market conditions an airline with a Moody’s Baa3 credit rating (equivalent to S & P rating of BBB-) on credit outlook “negative” would have to pay 250 to 275 basis points (2.50% to 2.75%) over the five-year swap rate. However, do not be surprised to see Air New Zealand issue their bonds at 200 points over swap rates for an all-up interest rate of 6.20%. Such is the pent-up retail investor demand for a restricted supply of corporate bonds to invest into.
NEW ZEALAND DOLLAR MARKET COMMENTARY
Central bankers calling the NZD’s tune
Following the plunge from the highs of 0.8800 down to 0.8000 in early August when sharemarkets tanked on the weaker global growth outlook, the NZD/USD exchange rate has zigzagged between 0.8150 and 0.8400 in still quite volatile FX markets. The Kiwi is either bought or sold by traders/speculators on a daily basis depending upon whether investment markets are in “risk-on” or “risk-off” mode. The incredibly skittish nature of the markets being such that it is impossible to predict the near term direction of the Kiwi dollar. Adding to the daily gyrations is the withdrawal of some global investment banks form the Kiwi-dollar interbank market, thus reducing trading liquidity/volumes and exaggerating movements. When global sharemarkets settle down there will be an opportunity for more stability in the NZD/USD currency market.
The world’s financial and investment markets built up high expectations last week ahead of the Jackson Hole speech by US Federal Reserve Chairman, Ben Bernanke that he would signal further quantitative monetary easing measures (“QE3”). A clear signal was not provided by Mr Bernanke; however he continues to express concern at the lack of employment growth in the US economy. Mr Bernanke needs to garner wider consensus support in the Fed before embarking on printing more money to help the US economy. He reiterated the need for the US Government to move on its fiscal policy as loose monetary policy has done almost all it can to help the economy back to positive growth. The markets, whilst not observing a green or red light to QE3, took heart from the speech with the Dow Jones Index rising on Friday 26 August and the Kiwi jumping up one cent to 0.8400. The markets will centre their attention on the next Federal Reserve meeting next month which has been extended to a two day affair to consider the requirement for a QE3.
The attitude, decisions and statements from central bankers is playing an increasing role in determining the immediate direction and pricing of the NZ dollar:-
§ Should the US Federal Reserve implement a QE3 monetary stimulus the US dollar itself can be expected to weaken against all currencies as additional supply of USD’s comes onto the markets. US economic data trends between now and the September Fed meeting may well determine the Fed’s decision. Employment and ISM manufacturing economic data this week will be early indicators as to whether the US economy is pulling out of its winter slump or not.
§ The Reserve Bank of Australia’s Governor Glenn Stevens is not moving away from his earlier view that the mining/commodities boom in Australia will see the economy through despite very weak domestic economic indicators. He still sees inflation risks ahead and his latest speech caused the Australian interest rate markets to remove some of their future pricing of official interest rate cuts. The AUD pulled back from $1.1000 to $1.0300 against the USD on the weaker global growth story three weeks ago. However, it has strengthened back to $1.0600 since, as the US contemplate further loosening and the RBA virtually rule out any monetary loosening. The NZD/USD rate follows the AUD/USD rate very closely and for the meantime the RBA monetary stance is dominating the NZD direction.
§ The European Central Bank has operated completely independently and separately to European political leaders in addressing the fiscal deficit and debt problems besetting the European economies. The ECB increased their official interest rates to 1.5% in March, which now looks like a policy mistake in the face of weaker economic growth and receding inflation worries. An interest rate cut in Europe to help consumer spending recover would seem necessary and that would weaken the Euro exchange rate against the USD from its current level of $1.4500. The Swiss do not want their currency any stronger and are intervening to stop its appreciation; the Germans are in the same boat as their export growth suffers from the Euro being too strong.
§ Focus will shift onto the Reserve Bank of New Zealand on 15 September with the quarterly Monetary Policy Statement. The tone and message from Alan Bollard can be expected to be totally different to what the RBNZ were saying in June. The outlook for the NZ economy in 2012 is now much more uncertain as lower global growth, lower agricultural export commodity prices and the high NZD/USD exchange rate all combine to drag growth down from previous forecasts of +4.00% to considerably lower levels. Whilst the NZ dollar stays above 0.8000, the RBNZ cannot raise official interest rates. The 15 September RBNZ statement could well be considerably more “dovish” than what the markets anticipate and lead to stand-alone NZD selling.
The high Australian dollar rate against the USD is doing serious damage to investment and jobs in the non-resources industries in Australia. The same is starting to happen to several NZ export industries as well. Wholemilk powder and other key export commodity prices (e.g. logs) are now decreasing and diverging from the NZD/USD movements. A sustained period of this separation of prices is disastrous for the NZ economy and eventually the currency markets will recognise this.