I might be misguided in an overly optimistic and overtly contrarian way in my old age (“the reports of my death have been greatly exaggerated!” – Mark Twain), however the pricing of market interest rates over this past week to new record lows is a step too far in my book.
The push down of two and three year swap interest rates to new record lows of 2.95% and 3.25% respectively is almost saying that the RBNZ will keep the OCR at the emergency 2.5% level for the next two or three years without change. The current market pricing reflects an extraordinarily pessimistic view of the global economy from here. It suggests a major double-dip economic recession internationally of equal severity as the March 2009 slump when world trade almost stopped. It also suggests that there is a reasonable chance of the RBNZ cutting interest rates, which seems to be entirely based on the RBA and ECB cutting rates, therefore we must follow.
Sure, there are seemingly insurmountable debt and deficit problems in Europe and Euroland is headed into economic recession; however that does not mean that the rest of the global economy collapses as well. The local moneymarket has over-reacted to international events of this last week and is also taking too much notice of local doomsday merchant economists who only ever see the glass as half empty. I would admit that recent domestic economic data has been a touch on the softer side with business/consumer confidence falling away from unrealistic high levels in the middle of the year. However, there are a number of positives occurring in the NZ economy which I think the interest markets are completely ignoring:-
§ Retail sales for the September quarter were substantially above prior market forecasts.
§ The residential property market has not declined as many had forecast, however gone are the days of expectations of major capital appreciation.
§ Export volumes and prices are still very healthy; a lower NZD/USD exchange rate into the low 0.7000’s would help the achievement of +3.00% GDP growth next year.
§ It has been a great spring growing season in the agriculture sector, production is up big-time.
§ Business investment is on the increase again with manufacturers taking advantage of the recent strong NZ dollar value to purchase new machines for a lower NZD entry cost.
I would not say that there are no risks to the more optimistic, glass half full view; however the interest rate markets are today almost pricing an “Armageddon” scenario for the global and domestic economy. I do not see that doomsday scenario transpiring into reality, as the US and Chinese economies are unlikely to be totally dragged down by Europe’s demise. US economic data is already printing on a stronger note and the Congressional Super Committee on the US Government deficit/debt situation will report with some solutions next week.
It was always going to enormously challenging for the RBNZ to unwind the emergency monetary stimulus they put in place in early 2009 with a 2.5% OCR. If the economy does expand at a +3.00% clip next year, Alan Bollard will have the right environment to justify and remove the stimulus by lifting the OCR to the “new normal” and “monetary setting neutral” levels of around 4.00%. Maybe the best thing Alan could do to help the economy lift to 3.00% growth in 2012 is to hint at interest rate cuts (without actually doing it) to get the NZ dollar down sooner rather than later. Nothing like picking your moment to jawbone the Kiwi lower to give you more monetary policy management flexibility later on.
NEW ZEALAND DOLLAR MARKET COMMENTARY
NZ Dollar short-term risks still to the downside
The unpredictable day-to-day volatility in the NZD/USD exchange rate continues unabated with the forex market reacting positively or negatively to the ever changing tide of econo-politico developments in Europe. Standing back from the daily market noise is always difficult in these situations; however it is hard to put up a strong and convincing argument that the NZ dollar should be roaring skywards at this time.
As has been argued in this column all year, the medium to longer term outlook for the NZ dollar value has to be positive as the NZ economy is an efficient supplier of protein to growing Asian cities. Foreign exchange rates are relative prices, and relative to the rest of the world on economic fundamentals there are certainly more positives than negatives for the Kiwi dollar. However, in the short-term (next few months) there are more risks to the downside for the Kiwi due to the following:-
§ Changes in Prime Ministers in Greece and Italy do not solve the economic and financial market problems in Europe. As the end-of-year approaches, investment market participants will be reducing their appetite for “risk” assets, including the risk currencies of the NZD and AUD.
§ The NZD/USD rate follows the EUR/USD and AUD/USD exchange rates and both the RBA and ECB are expected to cut interest rates again, thus weakening those currencies against the USD.
§ Lower global growth forecasts = lower commodity prices = lower commodity currencies.
§ Whilst the National Party look like governing alone (from the political opinion polls) at the upcoming general election, stranger things have happened in Dallas. Should the Epsom electorate voters not understand the subliminal messages from the PM and vote the National candidate in instead of Banksie, we could end up with the “rainbow” coalition of Labour/Greens. NZ First/Mana and Maori parties. The financial markets would not be expecting such an outcome and would vote with their feet on the prospect of more Government debt and higher taxes i.e. sell the Kiwi dollar down. The probability of this scenario eventuating are probably very slim, however it cannot be totally discounted.
§ RBNZ Governor, Alan Bollard takes my advice and hints at interest rate cuts (without actually doing it) in the early December Monetary Policy Statement so that the NZD depreciates. Such a cunning plan to lower the Kiwi’s value would lift our GDP growth prospects in 2012, thus providing Alan with the justification to return the OCR to more normal levels of 4.00%. He has wanted to remove the emergency monetary stimulus for some time; however earthquakes in Christchurch and financial quakes in Euroland have stymied his best intentions in this regard.
§ A continuation of the more positive US economic data will differentiate the outlook for the respective US and European economies, thus the USD preferred over the Euro.
As has already been witnessed, the path lower for the NZD/USD rate is not a smooth one, however the overall trend and sentiment still favours the downside over coming months.