Strategist

BNZ Strategist

Craig Ebert -
Download PDF

Economic Outlook
Political protest noted, the extent of the drop in today’s ANZ business survey, so soon, means we also need to wonder what might be bugging NZ firms from a practical point of view. To be clear, we are not about to slash our economic growth forecasts on the basis of today’s survey. However, it surely makes us comfortable keeping our GDP forecasts on the conservative side for the near term (as does the suddenly dry weather). As such, there seems further reason to question the strength of the Reserve Bank’s latest GDP forecasts, as well as Treasury’s (with an eye on its Economic and Fiscal Update, expected ahead of Xmas). Today’s news is certainly no reason to back off our story of inflation picking up – something that the inflation gauges in today’s ANZ survey gave more life to, in fact. This is consistent with the business costs portended by the new government’s policy manifesto, reinforced by the still-abating currency. While we watch for the possibility of the HYEFU over the coming fortnight, there are no significant NZ data over the period otherwise.

Interest Rate Outlook and Strategy
The global economic backdrop remains conducive to higher interest rates but a lack of measured inflation to date is keeping global bond yields in check. This dynamic continues to weigh on NZ yields. But as global economic expansion continues at pace, the odds gradually increase for an uplift in inflation pressure and global bond yields. That’s our 2018 view. Higher German rates next year could play a key role in driving US (and NZ) rates higher. Our view of higher US yields points to an eventual steepening in the NZ 2s10s swap curve and ultimately wider NZ-US 10-year government bond spreads as NZ government bond issuance is expected to step up next year.

Currency Outlook
The NZD has pushed lower over recent months. There has been some fundamental basis for the weakness with some wobbles in global risk appetite, weaker international dairy prices, a narrowing in the gap between NZ and US short term interest rates (as the Fed is expected to hike interest rates again in December), and the uncertainty raised by the change in NZ government. But we feel a lot of this news is now priced in by the market. Regards NZD/EUR, the cross has spent much of 2017 on a downward path, to be down 12% year-to-date. But this move was from a very high level and the cross remains some 6% above our long-term purchasing power parity estimate. The ECB’s gradual move away from quantitative easing and expectations of an eventual removal of the negative deposit rate, are likely to drive EUR higher and be the key factors supporting further weakness in the NZD/EUR cross.

BNZ Strategist

Craig Ebert -
Download PDF

Economic Outlook
The evolution of housing and construction are not only important for the outlook for economic growth, but also the trajectory of inflation. Last week’s RBNZ Monetary Policy Statement highlighted a weaker (although not weak) outlook for housing and construction, amid GDP growth projections that otherwise strengthened. This seems as much a function of a softer starting point as a genuine toning down of future prospects. Indeed, the leading indicators on home-building activity have perked up again over recent months and today’s Q3 concrete production figures poked a touch higher, albeit with significant regional variation. Latest building consents and construction firms’ activity expectations in the coming fortnight’s data will be worth monitoring. Sure, existing house sales are weak, dented by increasingly aggressive LVR restrictions. But across a range of indicators the broader housing market still looks in good heart – probably too good for the RBNZ to start relaxing LVR restrictions just yet.

Interest Rate Outlook and Strategy
Short term interest rates have hit a record low. The 90-day bank bill rate traded at 1.91% and some government rates have recently been bid below the cash rate of 1.75%. Domestic liquidity is gushing, as banks are well ahead of funding targets and credit growth is softer. As these conditions continue, the 2-year swap rate has a good chance of reaching a fresh low for the year, down towards 2.10%. The top of the range into early next year is probably more like 2.25% now, with global forces being the most likely source of any upside pressure. Meanwhile, the proposed new policy framework stemming from revisions to the RBNZ Act has had no bearing on our monetary policy outlook, in contrast to some others’ views.

Currency Outlook
Over the past 12 months, the NZD has depreciated against most major currencies, including significant falls against EUR, GBP, and CAD. This has closed up some of the long-term currency misalignment as measured by our purchasing power parity estimates. On a TWI basis, the NZD is currently very close to our long-term PPP estimate, supporting RBNZ Acting Governor Spencer’s recent statement that the NZD was ‘closer to a sustainable level’. Our PPP estimates have no bearing on our 1 to 2 year ahead projections for the NZD. Corporates with a longer-term focus, say 3 to 5 years ahead, should budget for lower NZD/EUR, NZD/GBP, NZD/JPY, and NZD/CAD cross rates. Over the longer-term horizon, NZD/USD is more likely to be higher than lower, while we have no strong opinion, one way or the other, on NZD/AUD.

BNZ Strategist

Stephen Toplis -
Download PDF

Economic Outlook

We have had a go at recasting our forecasts based on current information on likely government policies. This should be thought of as work in progress and will evolve as we get more detail. As they stand, our new forecasts will likely grate with those in the market forming a softer view on NZ (and the RBNZ). Big-picture, our GDP growth expectations are largely unchanged though different in composition; inflation more surely gets up around 2%; government debt threatens to track much higher than the Labour party has signalled and; corporate margins are crimped as input costs rise. For the record, the RBNZ’s August MPS published GDP growth track was 3.1% for the year ended March 2018; followed by 3.6% in 2019 and 2.9% in 2020. Our equivalents are 2.5%, 3.0% and 2.5%. Treasury’s Budget had 3.4%, 3.8% and 3.1% over the same period. If we are correct then there is clearly downside risk to government revenues which will be problematic for the government’s expenditure plans. There are no data of great significance over the coming fortnight.

Interest Rate Outlook and Strategy

The OIS market has pushed the timing of the first full 25bp rate hike to February 2019 from November 2018 and NZ 2 year swap has fallen 4bps to 2.16% largely on political headlines. We think that the NZ front end rally has been excessive. We suspect the politics-related receiving theme will run out of legs. We expect the RBNZ to hold the OCR at 1.75% next Thursday, but we believe the balance of recent economic developments will almost certainly see the Bank revise up its inflation forecasts. It is less certain what the bank will choose to do with its interest rate track. In any case, there seems very little chance that the RBNZ’s tone will be more dovish that it was in August and it may well be noticeably more hawkish. Our bias is for a constrained sell-off in the front end, seeing 2 year swap in a 2.10-2.30% range. 5s look too rich on swap curve against 2s and 10s.

Currency Outlook

Domestic political forces have seen the NZD underperform since the election, across a broad range of currencies. We see the NZD as oversold on this basis, given our view that the market need not fear a (small) change in government policy direction. Our short-term fair value model estimate has broadly tracked around USD0.72-0.73 since the election, supported by high risk appetite. This compares to current spot levels at sub USD0.70. A fading of the NZ political risk premium supports a closing of the valuation gap over the near-term and a broadly based recovery on most crosses. Next week’s RBNZ MPS should be NZD-supportive as the Bank lifts its inflation forecasts. We see no need to change our NZD projections, which have the currency anchored around USD0.69-0.70 through the next 12 months.

BNZ Strategist

Stephen Toplis -
Download PDF

Economic Outlook

As we await the (full) details of the new government’s policies, we do wonder what their net effect will be on inflation, amongst other things. Annual CPI inflation has firmed already, of course. In Q3 it got to 1.9%, from 1.7%. Not only was this higher than the 1.6% expected by the RBNZ but the source of the surprise was, in part, due to a rise in non-tradables inflation – the bit that the Bank, in theory, has more control over. Standard measures of core inflation have also firmed up, to around 2.0% y/y. However, the sectoral factor model version that the RBNZ computes, and puts emphasis on, kept lagging at 1.4% y/y. While this is important to note, it’s also worth pointing out that this measure of core inflation has not, in the past, been the be all and end all of OCR ups and downs. Of the upcoming data, October’s ANZ business survey (31 October) will be tangled up in government formation hiatus. However, we expect the Q3 labour market reports (1 November) to be robust to the election process.

Interest Rate Outlook and Strategy

Volatility in NZ front end rates remains exceptionally low. NZ 2- year swap is at 2.21% and has traded in just a 5bp range all month. A small sell-off on a stronger than expected CPI print this week couldn’t be sustained after the RBNZ’s preferred annual core inflation estimate showed no change at 1.4%. We look to the early-November labour market data, including wage measures, as the next significant local data release. NZ long end yields are following global bond direction where our bias remains for higher yields. NZGB-ACGGB 10-year spread looks too tight relative to front end pricing. NZGB Apr-23s look rich on fly against Apr-20 and Apr-27.

Currency Outlook

In our view there is a big difference between saying an exchange rate is high or strong and saying that it is overvalued. At current levels there is no doubt, in a long-term historical context, New Zealand’s real exchange rate is high, but this can be easily explained by the nation’s strong terms of trade. Moreover, adjusting the IMF’s estimates for currency over/under valuation for recent NZ TWI movements suggests that the NZD real exchange rate is currently fairly priced on a medium to long-term basis. Our near-term assessment is unchanged from our re-estimated NZD/USD short-term model that suggests the NZD is currently a little oversold relative to fair value around 0.73. We also look at Singapore’s managed exchange rate process and see it as impractical for NZ to adopt.

BNZ Strategist

Doug Steel -
Download PDF

Economic Outlook:
The election night outcome proved as inconclusive as the final handful of polls. With ‘special votes’ to be counted, we then await the result of negotiations to form the next government. From that we will still need to determine the paths of key policy, and make any adjustments to our macro-economic view as necessary. But there is more to note than government formation. One is the recent run of poor weather (too much rain) that has seen us nudge down our meat and dairy production and export volume outlooks for the current season; shaving our 2018 GDP growth forecasts to 2.9% from 3.1% in the process. For the coming fortnight, latest reads on consumer confidence and the PMI and PSI indicators will be difficult to judge given their proximity to the election. More interest will likely be in the Q3 CPI (due 17 October) whose annual inflation we think will stay at 1.7% y/y – inkling that inflation will not sag nearly as much as the RBNZ projects by early 2018, if at all.

Interest Rate Outlook and Strategy:
Last week’s RBNZ OCR Review did nothing to alter market pricing as the cash rate was held at 1.75% and guidance unchanged. It is likely to take more than one quarter’s slightly higher-than-anticipated headline inflation print to see the Bank budge. This is expected to keep short-end NZ rates range-bound. Near term, our bias for global yields is higher and that should flow through to the NZ front end, but RBNZ guidance is expected to cap 2y swap around 2.25% to 2.30%. The bottom of the range is seen around 2.10%. Multiple factors have seen US 10-year yields lift more than 30bps from their September low. We expect further gains, with a target of 2.60% by year end. This view translates into an NZGB 10y yield reaching 3.20% at that point. The influence on higher offshore long rates is expected to see the NZ 2s10s swap curve re-test at 120bps.

Currency Outlook:
The key USD indices are showing emerging signs of a broadly based recovery. In the context of a steady fall in the USD through much of this year, down over 10% at one stage, the approximate 2½% recovery has been fairly modest so far. We expect the recovery to progress further. Against this backdrop, the NZD is holding up well after some damage inflicted during August. We see fundamental support for the NZD at present via very high levels of risk appetite and NZ commodity prices performing well. If not for prospects of the USD reviving, we’d be thinking that the NZD ought to be heading a lot higher, rather than slip towards our year-end target of USD0.70.

BNZ Strategist

Craig Ebert -
Download PDF

Economic Outlook

There might yet be some important implications for New Zealand’s economic outlook from Saturday’s election. But with that race still looking so tight, and coalition permutations reasonably many, it seems pointless to conjecture about how our economic views might need to change. With today’s Q2 GDP report coming in as expected (0.8% for the quarter and 2.5% y/y) attention turns to “what next?” Recent economic surveys still signal a solid growth path underfoot, in spite of the election coming into sharp focus. Consumer sentiment is robust. And we will get further insight into the minds of business with the 26 September ANZ survey. Then there’s the 3 October NZIER Quarterly Survey of Business Opinion to check out – which respondents will have also have filled out pre-election. The more interesting surveys will be those reflecting post-election sentiment and activity, including for the housing market.

Interest Rate Outlook and Strategy

We still see NZ short end yields range bound, anchored by an on hold RBNZ. Economic developments have not been sufficiently different to August MPS projections to warrant any change of cash rate (1.75%), or rhetoric, from the Bank at its meeting next week, especially amid likely post-election noise and it being the first OCR review from the Acting Governor, Grant Spencer. Meanwhile, we remain of the view that long end yields will track higher driven by expected increases offshore including in Australia and the US. The latter reflects our expectations for more Fed funds tightening than implied by current front end pricing and a higher term premium as the Fed balance sheet reduction proceeds and the ECB and other central banks slowly unwind accommodative policy.

Currency Outlook

Central bank statements and expectations can kick around currencies over the very short term but we think other drivers are more important over the medium term. Relationships between NZ-global rate spreads and the NZD have weakened over recent years. Risk appetite and commodity price trends are more important drivers of the NZD than interest rate differentials. Our monetary policy expectations don’t have a significant bearing on our outlook for the NZD over the next year or two. High risk appetite – its highest level this year – supports the current level of the NZD. Our (unchanged) projections for a weaker NZD into year end and early next year assumes that risk appetite peels back from its current giddy heights. A weaker commodity price dynamic is expected to give further weight to that view.