Does the general election result change anything in terms of the outlook for future interest rate movements?

I doubt it, because international economic and financial market developments continue to dominate the sentiment and near-term direction of the local interest rate market. A National Government is returned to office, so really not a lot has changed. It still appears to me that in pricing-in interest rate cuts over the short-term and virtually no increases over the next 12 months, the NZ moneymarkets are still over-reacting by almost assuming an Armageddon/doomsday economic scenario is a given. My view remains unchanged in that an economic recession and maybe bank failures in Europe does not automatically drag the US and Asian economies down. In the very short term, ISM and PMI data in the US and China respectively this week, together with US employment figures on Saturday morning, will sway general market sentiment.

On the assumption that we do not have a global double-dip recession, the greater risk remains that our interest rates from 90-days to 10 years are 1.00% higher in 12 months time. Current market pricing is a long way below such a forecast. The more likely scenario in 2012 is that Governor Bollard finally has the opportunity (after being stymied by earthquakes and the European crisis this year) by June 2012 to remove the emergency monetary stimulus put in place in March 2009. The evidence and justification for his action in June 2012 will be an economy growing at 3.00% and the inflation risks that come with that, as well as the inflation that comes from an under-resourced construction sector.

The current interest rate market pricing of potential cuts to the OCR appears very much at odds with the sentiment and pricing in the currency and equity markets. They are not pricing-in Armageddon! The 8 December Monetary Policy Statement will be circumspect with all the uncertainties around Europe, however Governor Bollard will certainly not be endorsing the current market pricing of OCR cuts. 

NEW ZEALAND DOLLAR MARKET COMMENTARY

Election result interpreted as Kiwi dollar positive by the markets

The jump up in the NZ dollar exchange rate from 0.7400 to 0.7500 on Saturday’s general election result is not too surprising. The markets are satisfied that the second Key Government has a validated mandate to push ahead with partial state asset sales and economic policies that promote growth. The partial listing of four SOE’s is certainly positive for the NZ sharemarket, even if foreign ownership of the shares will be restricted.

The political result is positive for business and positive for the economy. Albeit that there is a fair amount of risk and uncertainty surrounding Europe right now, the underlying fundamentals of the NZ economy (grass growth and agricultural commodity prices) remain very positive and it is hard to see the Kiwi dollar being sold in such an environment. The risk in the short-term for further NZD depreciation to 0.7000 is that Europe totally implodes and the EUR/USD rates drops to $1.2500 (currently $1.3300), with the NZD/USD rate dragged down with the Euro. As we approach the end of the year, I still see global hedge funds curtailing their speculative activities against European bond markets and bank share prices.

Therefore, despite all the scaremongering locally from several economic commentators that Europe is going to pull the NZ economy under, my view is that market turmoil in Europe recedes somewhat over coming weeks and the NZ dollar stabilises in the 0.7400 to 0.7600 trading range. The very negative doomsday scenario for Europe is arguably already priced-into many markets, so the view is that sideways markets through the Christmas/New Year period will prevail, rather than continued heavy selling.  The 8 December Monetary Policy Statement from the RBNZ also has the potential to push the NZD up rather than down from 0.7500, as Governor Bollard really has to repeat his 27 October statement that interest rates will have to go up sometime in 2012.

Despite all the analysis and conjecture that goes into forming a view of where the Kiwi dollar will go next, we should be spending all our time understanding the demand and supply equation for copper prices. The copper price/NZD correlation exists because the Kiwi dollar tracks the Australian dollar, which in turn is viewed by the world as a proxy for Chinese industrial demand for copper. A “hard landing“ for the Chinese economy from monetary tightening earlier this year would send copper prices lower. A “soft landing” in China is more likely to see stabilisation of copper prices at current levels. Hence the stabilising Kiwi dollar position in the mid-0.7000’s over the next few months.