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.
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.
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.
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.
Thoughts on Q2 GDP
Dependent only on tomorrow’s manufacturing figures, our growth estimate for June quarter GDP remains at 0.9% (2.6% y/y). That is, based on the production-based measure. In terms of expenditure GDP we figure on a quarterly gain of 1.2% (2.4% y/y).
New Zealand’s growth cycle looks set to be extended for a further three years (or more). Low interest rates, fiscal stimulus and population growth are the key to this. Growth is, however, being adversely impacted by capacity constraints, particularly in the labour market. Normally, such an environment would portend significant inflationary problems but inflation (at least that measured by the Consumers Price Index) is absent. Accordingly, the Reserve Bank is on hold for some time. Meanwhile, the recently robust NZD looks set for a modest correction against the USD while strengthening against the AUD.
We continue to forecast a solid ongoing economic expansion. Economic growth is expected to average just under 3% over the next three years. But we remain toward the pessimistic end of the spectrum largely as we see little spare capacity to grow. Another tick lower in the unemployment rate adds to the case. The RBNZ, as per today’s Monetary Policy Statement, remains relatively upbeat on the economy’s growth prospects seeing growth exceeding 3% for much of the three years ahead. This includes stronger growth in domestic demand than we see. This is an area to watch ahead as competing forces such as an anticipated record terms of trade and a cooling housing market do battle. Business and consumer confidence have remained robust as we head into the 23 September General Election. Next week’s Q2 retail sales will be the latest gauge on how domestic demand has been travelling; probably a bit slower than in Q1.
Interest Rate Outlook and Strategy
Today’s RBNZ Monetary Policy Statement held no surprises. The OCR was held at 1.75% and is projected to stay there for some time. We formally push out our forecast for the first RBNZ rate hike May to August 2018 – still well ahead of the RBNZ’s expectation but not substantively different to market. NZ short end rates will likely be anchored by an on hold and neutral RBNZ. We expect NZ 2 year swap to (mostly) trade a tight 2.15% to 2.25% range. Global forces represent the key upside risk to NZ rates. If we are right and the Fed remains on track for further rate increases and other major central banks join in, then pressure will be for NZ curve steepening and lower NZ-global spreads.
We are struggling to see much upward force for the NZD from here and plenty of downward forces. Technicals and positioning both signal headwinds ahead; the positive terms of trade story is well priced; risk appetite must surely fall from its current elevated levels; election risk overhangs the NZD over the next couple of months; NZ monetary policy won’t be a supporting factor; and the USD looks heavily oversold. Certainly our year-end target for the NZD to go sub USD 0.70 looks a stretch at this juncture, but we remain comfortable in our call for a softer NZD towards year-end, against the trend of the past few months. We expect the US Fed and BoC to continue along the path of higher rates, and the ECB to signal and then begin tapering its asset purchase programme soon. BoE tightening is more likely early next year than this, while the RBA is expected to remain neutral. These forces support downward bias to the NZD on many of the crosses.
Could it be that the jinx of being in government in a year ending in 8 is about to end?