Thursday, January 30, 2014

No surpises from the RBNZ or the Fed

The Reserve Bank of New Zealand (RBNZ) left interest rates unchanged today, but signalled the tightening cycle will begin soon.

There was no knee-jerk reaction today to recent higher-than-expected growth and inflation data.  The press release was a continuation of their recent measured and calm communications strategy.  The Bank acknowledged the “economic expansion has considerable momentum”, indeed we expect the Bank will raise its growth forecasts at the March Monetary Policy Statement.

They also acknowledged the improving global growth environment, but also the uncertain impact on emerging markets of the timing of the withdrawal of the exceptional monetary accommodation that has been required in the major economies.  (More on emerging markets tomorrow.)

The high exchange rate gets a mention again but this is limited to its dampening effect on inflation in the traded goods sector and a reiteration of their view (which is consistent with ours) that the level of the NZD is unsustainable in the long run.  However, they don’t mention the strength of the NZD as a headwind to growth.  That perhaps signals the Bank is now more accepting of the point that the exchange rate is strong for a reason – the strength of commodity prices and the terms of trade.

The key paragraph in the release is as follows:
While headline inflation has been moderate, inflationary pressures are expected to increase over the next two years.  In this environment, there is a need to return interest rates to more-normal levels.  The Bank expects to start this adjustment soon.

That’s entirely appropriate. The case for a tightening is compelling indeed we think it’s been compelling for a while.  Growth is strengthening and inflation is rising yet the Official Cash Rate (OCR) remains at the historical low of 2.5%, some two percentage points below (new) estimates of the neutral rate.  If I were the Bank right now I’d prefer to be a lot closer to neutral!

The first hike will more than likely come in March when we expect the RBNZ to raise the Official Cash Rate 50bps from 2.5% to 3.0%.   We expect successive 25bp hikes at each Monetary Policy Statement after that for a total of 125bps of tightening in 2014 and an OCR of 3.75% by year end.  Further tightening next year will see the OCR at the (presumed) neutral rate of 4.5% by mid-2015.

That is, however, mostly a working assumption (albeit a thoughtful one!).  A number of factors will come into play that will determine the pace and quantum of tightening over this interest rate cycle.  At this point we are only estimating that neutral is 4.5%, let alone whether that will prove to be enough to keep inflation in check.

While we think the Bank has been at risk of over-playing concerns about the exchange rate, how the NZD tracks in the period ahead will still be a determining factor in the interest rate cycle.  So too will decisions by firms about the balance of hiring and investment they undertake to resource increased demand for their goods and services.  And while it looks like LVR speed limits are having an impact on activity in the residential property market, the same cannot yet be said about house prices.  (More on all those things soon too.)

As was widely expected in the US the Federal Open Market Committee announced a further trimming of its asset purchases today.  They announced a further reduction of US$10 billion per month (split between Treasuries and MBS) following the reduction of the same magnitude in December.   Monthly purchases will now be US$65 billion per month from the start of February.

There was little to get excited about in the Statement, although changes from last month were generally biased to the positive.  Rather than growth being “moderate” they said it has “picked up in recent quarters”.  On fiscal policy they stated the degree of restraint on growth “is”, rather than “may be” diminishing.  On the negative side there was a nod to December’s wayward payrolls report.

The FOMC is at pains to stress reductions in its asset purchase program are not on a pre-determined (although I'm sensing a pattern already!).   So long as conditions with respect to growth, the labour market and inflation continue broadly in line with expectations, we expect the FOMC to continue to reduce the program for asset purchases to be finished before the end of the year.

Thursday, January 23, 2014

Inflation and monetary policy in NZ and Australia

There were two inflation surprises this week, one here at home and the other across the ditch in Australia.  However, those surprises are unlikely to prompt surprise responses from either the Reserve Bank of New Zealand (RBNZ) or the Reserve Bank of Australia (RBA).

New Zealand’s December 2013 quarter CPI came in at +0.1% qoq and +1.6% yoy.  The quarterly print compared with expectations of -0.2% from the RBNZ, -0.1% average market expectations and our forecast of zero.


We have a situation In New Zealand in which GDP growth is heading towards 4% (compared with potential growth which we estimate at around 2.0% to 2.5%), inflation is heading towards the mid-point of the target band and the Official Cash Rate is 2.5%, some two percentage points away from the RBNZ (and our) estimate of neutral.  Spot the odd one out; it’s not difficult.

With higher growth looking more assured this year for all the reasons I’ve written about before (click HERE to go to the December 2013 issue of New Zealand Insights), the challenge for the New Zealand economy in 2014 is to curb excesses and manage constraints.  Remember it’s not the absolute level of growth that concerns the RBNZ; they are worried about growth relative to the potential of the economy to grow.  Growth in excess of potential absorbs spare capacity and eventually puts upward pressure on prices.  Apart from maintaining low and stable inflation, the RBNZ can do little to influence potential GDP. That’s largely in the hands of firms, government and decisions by individuals about education and training.

New speed limits on high LVR lending are doing a part of the job, but higher interest rates were always going to be part of the equation.  Regular readers will recall I thought the RBNZ should start the tightening process in December last year.  Indeed if I were the RBNZ right now, I’d prefer to have 25bps under my belt already.  Given this year’s challenge, the risk is the RBNZ falls behind the problem.

When the RBNZ didn’t tighten in December last year I shifted my first rate hike expectation to +50bps in March (and +125bps in total in 2014 for an OCR at 3.75% by December this year).  Given this inflation result, I’m even more confident in that expectation.  While it’s a possibility I don’t think they will hike rates at the OCR review next week, although I obviously wouldn’t complain if they did.  While I haven’t agreed with everything they've said and done I give the RBNZ 10/10 for their recent communications strategy; I think they would prefer to wait for the March Monetary Policy Statement when they get a better opportunity to tell their story.

And what about the exchange rate?  As I’ve said before, I think the RBNZ is worrying too much about the New Zealand dollar.  The NZD is where it is for a whole host of reasons, not the least of which is historically high commodity prices.

The other inflation surprise this week was in Australia where December 2013 quarter inflation came in at +0.8% qoq.  That followed the surprisingly high 1.2% qoq increase in the September quarter.  While that’s 2.0% in only six months, the annual rate is only 2.7% for the year to December on the back of low prior quarter out-turns.

The situation in Australia is different from that in New Zealand.  Over there growth has been slowing, the RBA has been easing and the Australian dollar has been falling.  It’s not surprising that inflation has moved higher on the back of the exchange rate depreciation.  Given that’s the case, the RBA will “look through” the recent higher than expected results.

While our Australian economics team is seeing encouraging signs in business confidence, housing construction and retail sales, they expect the RBA to sit on their hands with the cash rate at 2.5% until mid-2014.

Tuesday, January 21, 2014

January QSO: Outlook for 2014

Today we released the January 2014 edition of our Quarterly Strategic Outlook.

The December quarter capped off another good year for equity investors. Developed market global equities were the best performing asset class in 2013, returning nearly 30% in local currency terms. In contrast to last year, higher yielding growth assets such as global and domestic listed property underperformed the broader market. Rising bond yields reduced the relative attractiveness of these assets to yield chasing investors. This partly explains the underperformance on New Zealand shares, yet domestic stocks still returned an impressive 16.5% for the year.

Rising yields also resulted in cash outperforming both global and domestic bonds last year, with New Zealand government bonds producing their first negative return since 1994. This was reinforced by retail investor rotation out of bonds and into cash and equities during the year.

Equity markets exceeded most investors’ expectations in 2013. In contrast, economic growth generally underperformed expectations. This pattern could be reversed in 2014 if investors expect anywhere near the same returns as last year.

Rising global growth, subdued inflation and accommodative monetary policy does promise another year of healthy equity returns versus bonds. The main risk to this view is if strong US growth leads to a sharper than expected decline in the unemployment rate, and inflation subsequently ticks up as ‘spare capacity’ is used up, which sees the market price an earlier than expected exit from zero rates.

2014 will mark the five year anniversaries of the Global Financial Crisis induced trough in markets and the end of the global Great Recession.  It has been tough going ever since, but as we head into the New Year the outlook is a tad sunnier.  That’s not to say it won’t be any less challenging; there is still considerable work to be done to secure a brighter, stronger, more robust future.

This Outlook provides our latest thoughts on the global economy along with asset class and portfolio positioning commentary from our Head of Investment Strategy Keith Poore.

Click HERE to go to the full document.