The local interest rate markets will be focusing on every word uttered by the RBNZ Governor at this Thursday’s OCR review. Having indicated in early June that the timing of the first OCR increase was being brought forward to December with a more upbeat assessment of the economy, the RBNZ have only seen stronger economic data and elevated inflation risks since. However, I doubt that Alan will agree with latest bank economist predictions that the first OCR hike will be September. Alan needs to buy some time here with a non-committal statement that does not signal an earlier tightening bias. The problem is the exchange rate. He knows all too well that any hint of the market interpreting the Thursday statement as marginally hawkish will send the NZ dollar even higher. Typically, the RBNZ expressed surprise at the market’s bullish interpretation of the June, MPS. The RBNZ cannot afford to make the same mistake again of miss-reading how the markets will react to their words. A very cautious and bland statement will be the result.
Here are the main points I expect Alan to highlight on Thursday:-
§ The NZ economy has been more robust than they expected over the past six months, due to strong export growth.
§ Inflation risks and inflation expectations have increased due to the stronger economic growth; however the higher NZD/USD exchange rate will reduce prices on imported consumer items and keep inflation in check.
§ Global growth forecasts for 2011 and 2012 are being revised downwards, pulling our key export agricultural commodity prices downwards. As a result, NZ GDP growth forecasts for 2012 may have to be also revised downwards as the high NZD/USD exchange rate has a damaging impact on exporter profits, investment and jobs.
§ The previous buoyant economic conditions in our largest export market, Australia have turned poorly and the previous low NZD/AUD exchange rate is no longer helping our manufacturing/food exporters into Australia.
§ Overall credit growth remains very subdued, however it appears the Auckland housing market is starting to see upwards price pressures as a lack of supply of new and existing homes lop-sides the market demand/supply equation.
§ The NZ dollar has strengthened on its own account from international capital flows not wanting to be in either the USD or EUR and looking for alternative safe haven currencies. That demand for the NZD is likely to reverse when the US resolves their debt ceiling issue.
All Alan can really do is jawbone the currency down, in the hope the NZD/USD rate is much lower come September/October time when he will need to start the removal of the monetary stimulus he put in place in early 2009.
Demand outstrips supply of corporate bonds
The strong investor demand witnessed for the recent Genesis Energy and “Z”/Greenstone Energy corporate bond issues indicates a severe shortage of supply of new bonds coming onto the market. The reasons for the supply shortage are three-fold:-
§ Large corporate borrowers tapping the US Private Placement debt market to obtain the long tenors they desire, thus no need for them to issue in the local market.
§ Local government issuers holding-off until the new Local Government Funding Agency is in place later in the year where they should be able to obtain their debt at a smaller credit margin for longer terms.
§ The banks now have their funding books in order to meet RBNZ core funding ratio requirements and are not experiencing much lending growth on the other side.
Therefore, the way seems very open for both old and new names to issue debt through the local corporate bond market. From the survey of weighted-average debt terms conducted by APRM in June, such names as WaterCare and Contact Energy would appear to have a need to lengthen their debt maturities. Telecom NZ is in a state of flux with the split into two companies therefore will not be an issuer at this time. There have been market rumours that Air New Zealand is contemplating a domestic corporate bond issue for the first time. Some listed property trusts still appear over-reliant on short-term bank debt; however they are arguably a harder sell to investors in terms of their industry sector risk. Fletcher Building has issued subordinated Capital Notes in the domestic market previously and would be a popular name for a senior bond issue. Fonterra has recently issued debt in the Australian market; however their name would also attract heavy investor support. Listed global freight company, Mainfreight has probably reached the debt levels that they should get a credit rating and diversify away from solely bank debt. Investors are advised to stick to the quality names mentioned above and avoid the near-junk bonds that some investors are currently painfully experiencing a restructure of with Blue Star Print Group.
NEW ZEALAND DOLLAR MARKET COMMENTARY
What could reverse the Kiwi’s direction?
New Zealand has been heavily favoured over recent times as an attractive currency destination for international funds seeking a safe-haven away from the USD and Euro. The Kiwi has been favoured over and above the Aussie dollar as the outlook on our interest rates is up, whereas theirs is down. Our economic data has been stronger than Australia’s of late as well. Can this favoured status for our currency last and propel the NZD/USD rate to 0.9000 and higher as several bank economists are now picking? Two statements from our monetary industry leader and dairy industry leader are likely to influence the NZD currency mark?et sentiment in the short-term:-
§ This Thursday’s OCR Review by the RBNZ provides the opportunity for Governor Bollard to “jawbone” the NZ dollar down as he will realise the potential damage a 0.8500 to 0.9000 NZD value will have on the export sector that is providing all the growth to the economy. The RBNZ statement cannot allow any interpretation by the markets that it is even marginally hawkish, as that would send the NZD higher still. The domestic economic data demands an ending of the monetary stimulus, however the RBNZ will know that they cannot even hint at a signal that they might be hiking the OCR earlier than what they have already indicated. Who would have his job?
§ There is no indication yet that Fonterra is even contemplating a statement on their 2011/2012 milksolids payout forecast to dairy farmers, however what Chairman, Sir Henry van den Hayden says in this respect may have more impact on the NZD value than what Governor Bollard verbalises. It is not publically disclosed (yet) as to what level Fonterra have sold wholemilk powder (“WMP”) forward at the previous high prices and to what percentage of the next 12 month’s export sales they have hedged the currency risk, however recent material market price movements in both variables suggest that the current $7.15 to $7.25/ kilo milksolids payout forecast could be under threat of a downward revision. That 2011/2012 forecast did build-in lower WMP prices and a higher NZD/USD exchange rate, however the latest lower WMP/higher currency movements are arguably well in excess of Fonterra’s expectations. A lot of the speculative Asian money that has come into the NZD over recent months has done so on the back of the diary price boom. Confirmation from Fonterra that the milksolids payout forecast has to be lowered would certainly be a negative for the Kiwi dollar. The Europeans and Americans have released additional volumes onto the globally-traded WMP market; this is why the WMP price is now falling rather rapidly.
The Kiwi dollar is now in a massive “over-shoot” territory, however there has to be specific New Zealand negatives to reverse the upward momentum. A general recovery by the USD in global FX markets after the US Government sort their debt ceiling deal may bring the NZD/USD rate back down, however all the other cross-rates would remain stable at the their elevated levels. The ANZ Commodity Price Index due for release next Monday 1st August will be another reminder to international investors in the NZD that our commodity prices have reversed dramatically.
The speed at which the NZD/USD rate has gone up from 0.8100 to 0.8650 over recent weeks suggests a vulnerability to an over-brought market and thus potential for a pull-back just as sharp. What the catalyst will be for specific NZD selling is hard to predict, however my guess is that it will be more to do with milk powder than monetary policy.