1.      At what point in time will the RBNZ be forced to change the pessimistic tone to their economic outlook? I would say about April; however every other commentator has moved their timing to “the second half of the year”. Waiting for absolute confirmation of inflation producing economic growth is no way to manage monetary policy – you will always be behind the 8-ball and cause too much collateral damage with subsequent rapid tightening action i.e. the NZD spiralling up and thumping the productive export sector once again. When will they learn from past mistake!!

 

2.      Are the RBNZ on another planet to the rest of us when they voice surprise that the “low” interest rates have not stimulated the economy as much as they thought it would? SME’s and households are paying higher credit margins over the banks’ cost of funds. One major Australasian bank was paying one of our investor clients 5.30% p.a. for a 12-month deposit for $1m last week. The OCR at 3.00% and 12-month wholesale swap rates at 3.40% are completely irrelevant to the vast majority of players in the economy. The banks’ costs of funds are closer to 5.00%, as I have repeatedly stated all year. Doesn’t the RBNZ understand that the cost of money (interest rates) is where borrowers and investors meet on price and transact – Economics 101!

 

3.      Will holding official OCR rates so far below true market interest rates be problematic for the RBNZ in 2011? Yes, I think so. One can certainly envisage the situation in mid- 2011 of Mr Bollard raising the OCR in 0.50% bites from 3.00% to 5.00%, however it having no impact on the economy, or borrower or investor behaviour (as they have been dealing at 5.00% for 12 months already). All that will happen is the NZD will appreciate as New Zealand will be the only country in the world increasing official interest rates at that time. Thanks Alan! - you created this OCR pickle, now you find a way out that does not upset our GDP growth over coming years.

 

4.      Who would have picked the US Government 10-year Treasury Bond yields to increase to 3.50% from 2.50% over the five weeks after the Fed Reserve announced their massive bond buying programme in QE2? Well – I thought long term rates would increase as it was a classic “buy the rumour, sell the fact” outcome in the bond market. The increase in our long-term swap rates over recent months should have been of no surprise to borrowers. The US bond market is currently pricing in a stronger US economy and associated higher inflation over coming years.

 

5.      From which parts of the NZ economy will the inflation come from in 2011 and 2012 that will require “tighter side of neutral” monetary policy settings to contain it? Certainly not from excessive demand in the retail and housing sectors that the RBNZ are pre-occupied with. As always, the price increases in the economy will be local government rates, electricity, insurance premiums, commodity/food prices and energy prices. Do higher interest rates/higher currency value influence price-setting behaviour in the aforementioned? No! 

 

6.      Will PM John Key and Finance Minister Bill English react to the RBNZ Governor’s veiled threat that monetary policy can be looser for longer in 2011 if fiscal policy is tightened in the May 2011 budget? If you were our Finance Minister would you slash Government spending/social assistance programmes in an election year? I don’t think so! Mr Key and Mr English are relying on 3% plus GDP growth to correct the Government’s finances. My summation is that they will be correct to rely on that and shouldn’t listen to the Governor if they want to be re-elected. Make the unpopular economic policy decisions at the start of the second term is more appropriate advice to the PM and Finance Minister.

 

7.      Will the banks increase deposit and lending interest rates in equal amount to the 2.00% increase in the OCR from 3.00% to 5.00% next year? No! The banks are flush with cash with the slow credit growth and the large corporate borrowers have gone to the USPP debt market and are repaying bank loans. If the banks are not lifting their lending volumes next year, they are hardly likely to take in more money at higher deposit interest rates.

 

8.      Will borrower’s credit spreads/margins continue to decrease? Looks like they will reduce further with the big corporate boys getting their long-term debt from the USPP market at lower margins than local bank pricing. The way will be open for second-tier corporate borrowers to offer corporate bonds in the NZ domestic debt market to Mum and Dad fixed interest investors next year. This leaves the banks’ only lending to the “no-growth” home mortgage market and SME’s. The natural consequence is a lowering of fees and margins to sign-up corporate commitments.
 

  

 

Here are eight NZD foreign exchange market questions to ponder over the beach, beer and BBQ holiday period:-

 

1.      What does a better performing US economy and continuing deterioration in the sovereign debt crisis in Europe mean for the NZD/USD direction? Seems to be one-way traffic to me as the NZD/USD will follow the EUR/USD rate down to $1.2500 over coming weeks (currently $1.3140). The close correlation/linkage drives the Kiwi near to 0.7000.

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2.      Who could be the big buyers of Kiwi dollars over coming months? Well, it is not going to be carry-traders, hedge fund, Uridashi bond or Asian investors chasing yield return. They are much more inclined to invest in the larger neighbouring AUD’s. I could see Australian corporates seeking to buy NZ businesses and manufacturers at a cheap NZD/AUD cross-rate to supply into Australia at a low cost base. If and when the Kiwi does go below 0.7000, our large exporters such as Fonterra will be heavy buyers of Kiwi as they hedge projected USD receipts forward.

 

3.      Who could be the big Kiwi dollar sellers over coming months? There still appears to be some legacy long-NZD speculative position holders who have yet to close-down by selling NZD’s. If the People’s Bank of China increase their interest rates again, commodity prices will fall and this in turn causes new speculative selling of the AUD and NZD against the USD.

 

4.      Will historical GDP growth data prompt further NZD selling? What happened in the NZ economy in July, August and September is on the surface irrelevant to FX markets that supposedly are always looking forward. However do not dismiss a sharp sell-off the below 0.7300 after Thursday’s figures if the September quarter’s number is less than 0.0% i.e. negative.

 

 

5.      What is the most likely scenario for NZD/USD movements in 2011? The more probable scenario is a stronger USD globally against the Euro and Yen pushing the NZD/USD rate to 0.7000 and maybe a bit below over coming months. The lower NZD/USD rate will allow USD exporters to hedge and thus secure robust profitability for 2011 with the high export commodity prices. From March/April onwards the risk increases that the NZD will be forced back up again to 0.7500 as NZ is the only country increasing its official interest rates in 2011. By March/April the forward looking NZ economic indicators should be sufficiently strong to cause a RBNZ U-turn from their current benign economic outlook. 

 

6.      What are the interest rate differentials to US interest rates telling us? It pays to look at the gap in the two-year swap rates, not the 90-day rates as the NZ 90-day wholesale rates are held artificially low at 3.20% by the RBNZ’s OCR settings. The two-year swap rate differential lead-indicator points to 0.6500.

 

7.      Will the NZD depreciate if Standard & Poor’s downgrade NZ’s sovereign credit rating? The Kiwi would certainly be sold by all and sundry if S & P’s took that action. However, I rate this as a very low probability of actually happening. S & P’s seem concerned at NZ Inc’s vulnerability to global financial market shocks i.e. borrowing markets seize up again for NZ banks who are on-lending the funds to highly indebted NZ households. It is an exaggerated concern in my view and S & P’s are far too pessimistic on their GDP growth forecast for NZ of 1.4% for 2011. They appear to be a very long way behind the times and not understanding what drives growth in the NZ economy i.e. export prices (which are ate 30-year highs.

 

8.      Is it disturbing that the letters that make up our “Kiwi“ currency are the same as “Wiki” leaks, suggesting that there is some international conspiracy and plot to destabilise the currency. Ian Wishart could write a book about that, but we all have more important things to think about over Xmas. Have a great break!