Thursday, October 29, 2015

RBNZ leaves options open and FOMC keeps December "live"

After three successive cuts in the Official Cash Rate since June, the Reserve Bank of New Zealand (RBNZ) left interest rates unchanged today.  However they signaled “some further reduction on the OCR seems likely”, though this will depend on the emerging flow of economic data.

The Banks reading of economic developments is much the same as ours: global growth is below average with concerns about future prospects centered on China and East Asia.  At the same time global inflation remains low.  Dairy price weakness continues to weigh on domestic farm incomes and it remains to be seen how sustainable the more recent increase in prices will prove to be.  House price inflation remains a financial stability risk and while residential building is accelerating, it will take some time to correct the supply shortfall.

On a brighter note the Bank notes the recent robust growth in the services sector and construction driven by strong net migration, tourism and low interest rates.

The Bank expects inflation to return to “well within” the 1-3% target band by early 2016.  We concur.  That’s in response to the weaker exchange rate and as the earlier impact of lower petrol prices fall out of the annual calculation.  However they also note the more recent appreciation in the exchange rate which, if sustained, would require a lower interest rates path than would otherwise be the case.

I still think there’s another 25bp cut in the OCR on the cards and that this will be delivered at the December Monetary Policy Statement.  That’s based on an expectation the recent strength in exchange rate will prove to be more sustained than desirable.  But if we take anything from today's Statement its that a December cut is not a done deal.

Earlier this morning the US Federal Reserve left interest rates unchanged and, if anything, surprised markets by keeping “live” the prospect of an interest rate hike in December.

As you know we’ve been reluctant to completely dismiss the chances of a rate hike this year – though acknowledged this would require some stronger labour market data, better news on global growth (particularly China) and less general angst in financial markets.

Indeed today’s Statement appeared less concerned about global developments with the Committee removing the reference in the September Statement that those developments could restrain retrain economic activity somewhat and put further downward pressure on inflation in the near term.


So December “lift-off” is still on the table, though as with the RBNZ, their next move will depend on the data before the meeting in mid- December.  Markets are now pricing in a slightly less than 50% chance of a rate hike at that meeting which is probably about right.  But some stronger domestic data suggesting the likely low print for Q3 GDP (our forecast 1.2% saar) is just a blip will see that probability move to over 50%. 

Wednesday, October 21, 2015

Quarterly Strategic Outlook - October 2015

This week we released the October 2015 edition of Quarterly Strategic Outlook.  The executive summary is below or click here if you want to access the full document in PDF format. 

The worst quarter in global share markets since the depths of the 2011 euro crisis does not portend the start of a prolonged bear market.  China is not collapsing, global share market valuations are not expensive, US interest rates will not rise materially, the global banking system is better capitalised than in previous years and there are no major housing market bubbles to bring it down.

Recent global growth angst has centred on China.  Concerns were that that a sharper than expected slowdown in the world’s second largest economy would precipitate a slowdown in global economic growth. Indeed China worries had a direct impact on sentiment towards the broader emerging economies, commodities and major developed-economy exporters such as Japan and Germany.

We believe that China growth risks are being overplayed: we are not in the China hard landing camp.   China is going through a challenging transformation but long term we remain of the view that a slower China is a more sustainable China.

More recently there have been increasing signs of “green shoots” of recovery in China.  The good news for exporters of consumer goods to China is that Chinese consumers remain in good heart.  Consumer confidence rose to a 15-month high in September, allaying fears that the recent share market correction would have a detrimental impact on household spending.

Concerns about global growth saw the US Federal Reserve leave interest rates on hold in September.  We still believe an interest rates increase is coming; it’s simply a question of when.  A hike this year is possible, but it’s looking increasingly likely that “lift-off” for US interest rates gets postponed into 2016.

In New Zealand we expect growth to come in at a lower but still solid 2.0 – 2.5% pace over the next 2 years.  Lower growth along with persistently low inflation has allowed scope for interest rate reductions.  We expect one further cut in the Official Cash Rate to 2.5% before Christmas.

The recent correction in shares has restored some value to markets such as the Unites States and New Zealand while other regions such as Hong-Kong listed China shares and European shares have become increasingly inexpensive.

The defensive characteristics of New Zealand shares came to the fore again over the September quarter, limiting the losses to a third of global shares but it still represented the weakest quarter for domestic shares since June 2012. Dividend growth has been a key support for New Zealand shares over the past year but this will slow going forward as distributions have outpaced earnings in recent quarters as companies have responded to dividend hungry investors.


The New Zealand dollar is close to fair value at current levels but the balance of risks are probably to the downside in the near term while China worries are still in focus and domestic and US monetary policy expectations are still diverging.