When will central banks react to inflation?
- Higher inflation and the prospect of a reduction in central bank support is becoming a concern among financial market participants.
- We think this risk is low given most economies have spare capacity that is keeping unemployment rates higher and inflation lower than central banks desire.
- The ongoing threat of higher inflation and reduced monetary stimulus, however, is likely to lead to choppy trading conditions as investors manage the transition away from the low inflation and falling interest rate environment seen in recent years.
- We hope that the following Q&A gives you an insight into our thought process.
RBNZ to drive retail rates lower
- The RBNZ has confirmed that cheaper bank funding will be here in time for Christmas via its Funding for Lending Programme (FLP).
- This will provide fresh impetus for banks to lower lending and deposit rates.
- Lower mortgage rates will likely boost an already-booming housing market. Lower term deposit rates may encourage consumer spending and a hunt for yield.
Economic strength to challenge the RBNZ’s dovish stance
- Market expectations of additional Reserve Bank of New Zealand (RBNZ) stimulus, for instance moving to a negative Official Cash Rate (OCR), have been tied to continued cautious communication from the central bank. Interest rate markets today price an OCR of -0.25% in one year’s time.
- The economy, however, is in much better shape than the RBNZ expected, which presents a challenge to its uber-dovish stance and the prospect of a negative OCR next year.
- In our view, the likely launch of a Funding for Lending Programme (FLP) as part of its 11 November Monetary Policy Statement (MPS) further reduces the need for additional stimulus.
- We see the distribution of future interest rate outcomes skewed higher.
The further consequences of lower interest rates
- As market interest rates in New Zealand decline further, additional consequences are revealing themselves. The theme of accelerating progression of longer-term trends continues.
- Wholesale interest rates continue to decline, with the Government’s PREFU announcement being the catalyst this week, due to a $10bln reduction in the size of the Government Stock issuance program for the 2020/21 fiscal year. The five-year New Zealand Government bond now trades at a negative yield, joining the one and two year maturities. 35% of outstanding nominal New Zealand Government Stock is now in the “negative rate” club.
- This week the Auckland Council issued the longest maturity bond in New Zealand for more than fifty years. The ability of a council to issue 30-year bonds in the domestic market is a notable milestone in the ongoing development of the New Zealand capital market.
Negative cash rates – The afterburner for asset prices
- The RBNZ’s stated preference for a negative OCR, should further stimulus be required, has encouraged the New Zealand market to expect negative wholesale cash interest rates next year
- This forward guidance on the potential for negative rates has led to large declines in retail interest rates and is having a powerful and positive impact on all asset prices
- This week a New Zealand government bond closed with a negative yield for the first time
Bond market takes note of RBNZ dovish shift
- We think the RBNZ reaction function has become more dovish with lower and flatter yield curves the primary goal in the face of persistent health-related downside economic risks.
- The Bank expanded its QE programme by more-than-expected last week from $60bn to $100bn and said it is prepared to implement a negative OCR alongside direct lending to retail banks at interest rates close to the OCR, if required.
- Interest rates have fallen in response, but NZ government bonds now look expensive versus their global peers and a sharp rise in breakeven inflation rates suggest that economic risks may lie in both directions.
Shadow banks shine light on mortgage deferrals
- Some of New Zealand’s non-bank mortgage lenders have provided detailed data that illustrates they appear well-positioned to weather an increase in non-performing loans when COVID-related loan deferrals expire
- Our various probes into the big banks indicate no cause for alarm, albeit we expect loss provisioning needs to rise and small to medium-sized enterprise (SME) lending trends need to be monitored
A bold bounce
- Many economies, including New Zealand, are re-opening and recovering faster than expected
- High growth rates are normal after such a large contraction in activity and the recovery, so far, is partial
- Ongoing policy stimulus is expected, given the residual uncertainty
Large Fiscal Spending Promises
- Budget 2020 revealed larger-than-expected potential spending in response to COVID-19.
- However, detail was lacking on many spending priorities.
- The accompanying larger bond issuance programme may prove difficult for the market to digest, placing upward pressure on government bond yields.
Will RBNZ QE help bridge the gap and how does it work?
What is the Reserve Bank of New Zealand’s (RBNZ’s) Quantitative Easing (QE) programme?After cutting the Official Cash Rate (OCR) by 75bp to 0.25% on March 16th, the RBNZ launched its Large Scale Asset Purchase (LSAP), or QE programme, just one week later. LSAP has a target to buy $30bn of government bonds over the next year; equivalent to 10% of Gross Domestic Product (GDP) and, at the time, almost 50% of outstanding bonds ma...READ MORE
QE in New Zealand – A rising tide lifts most boats
- The RBNZ’s quantitative easing (QE), Large Scale Asset Purchase (LSAP) programme has kicked off to a very promising start.
- In a tug-of-war between massive Reserve Bank purchases and NZ Treasury issuance, the Reserve Bank is winning.
- The New Zealand Local Government Authority raised $1.1billion in new bonds issued today – a record amount.
- Along with better COVID-19 news in New Zealand and a rebound in equities, we are starting to see better activity in high grade NZ credit.
- The market is hoping this will flow through to the broader credit market. Early signs are encouraging, but the jury is out on the poor cousins at the lower end of the credit spectrum.
How this could be different to the GFC
- Headlines around COVID-19 outside of Asia have continued to worsen and, coupled with the oil spat between Russia and Saudi Arabia, have sharply reduced investment sentiment and created pockets of financial stress.
- While sentiment is clearly downbeat, we need to recognise that there is still a wide range of outcomes that can occur.
- In the event COVID-19 does result in recession, note all recessions have been different.
- While this volatility is unsettling, it is important to put this sell-off in historical context.
Surprise cuts necessary, but not sufficient
- Overnight, the US Federal Reserve executed an out-of-cycle 50 basis point cut as financial conditions have deteriorated sharply over the last week.
- The closed circuit of declining confidence driving lower risk appetite, leading to increased financial stress and back to declining confidence, can be broken by government fiscal policy and monetary policy stimulus.
- We expect a concerted global effort across governments and central banks to support economic growth. New Zealand will be part of that effort.
Monitoring the US leveraged loan market
Investors have their noses to the wind for the source of the next crisis. The terrifyingly titled pile of debt, known as “leveraged loans”, could be starting to pong. At Harbour we remain vigilant, monitoring the US market, but taking comfort in the structure of markets down under.
Leveraged loans are simply private market borrowing by sub-investment grade companies. The US leveraged loan marketplace provides well over $US...READ MORE
NZ Monetary Policy: Diminishing Returns
The Reserve Bank of New Zealand (RBNZ) kept the Official Cash Rate (OCR) at 1.0% at its OCR Review this week, surprising the market with a rather sanguine tone, given the deteriorating global backdrop.
The RBNZ noted that both fiscal and monetary policy have scope to provide additional stimulus.
As the OCR plumbs new lows, questions are being raised over the efficacy of additional rate cuts.
This note highlights potential i...
Banks make a start on new capital
A new capital security issued on Tuesday night by Westpac Banking Corporation (Westpac) has highlighted the lack of higher-yielding opportunities available for New Zealand-based investors.
Banks fund the loans they make from deposits, bonds and shareholders’ contributions. In Australia, that’s also the order in which funds are repaid in the event of default. To go into further detail, there’s also a class of securities that...
Responsible investing extends beyond a green label
Contact Energy has announced its intentions to raise capital via a “green bond”.
A green bond is a debt security that has been verified to be backing assets, or projects, that have positive environmental or climate change benefits.
Green bonds can bring societal benefits by facilitating funding for projects with positive environmental impacts. Just as credit ratings indicate the likelihood of a bond defaulting, the green ...
Core NZ inflation pressures, lifting towards 2 percent
This week saw the release of NZ CPI inflation for Q4 2018. While headline annual inflation measure remained below 2%, the details showed core underlying pressures a little stronger than expected and continuing to lift to target. Rather than sparking any immediate change in policy direction, in our view, the CPI release will see the RBNZ continuing to “watch, worry, and wait”.
Leading into the CPI release, the market had been...
Harbour Investment Horizon: Fiscal Policy Outlook
There is growing coverage in the media that a slowing economy could force a fiscal tightening to stay within the government’s fiscal responsibility rules.
There is little evidence that the market is concerned with this risk, with the New Zealand government bond yields trading below the US for the first time in 25 years.
While providing important political discipline, there is also some flex in the fiscal responsibility rules, ...
Harbour Navigator: Deflationary risks in New Zealand abating
A key theme for the New Zealand economy in 2018 has been the potential crossroads facing the economic outlook. For the past 5 years, we have seen strong economic activity and low inflation keeping interest rates low and asset prices high. However, looking forward there are signs that economic activity is moderating at the same time as inflation pressures are emerging.READ MORE
The Changing Face of the New Zealand Credit Market
Over recent years the New Zealand credit market has been going through something of a quiet revolution. The borderline between bank lending and fund management is becoming blurred. Fund managers are stepping into areas traditionally dominated by banks, as regulatory reform has imposed higher capital costs on banks. Fund managers are broadening their investment choices and the range of bonds issued has become more varied. There...READ MORE
A New Reserve Bank Governor and Policy Targets Agreement
Adrian Orr started yesterday as the new Governor of the RBNZ, and earlier this week, signed a Policy Targets Agreement (PTA) with the Minister of Finance, Grant Robertson. As widely expected, the announcement included many of the outcomes of Phase 1 of the Government’s RBNZ Review; reaffirming the RBNZ’s position as a flexible inflation targetter; adding a dual mandate of “supporting maximum sustainable employment”; and, shift...READ MORE
New Year, similar themes
This New Year brings with it a slew of market outlook articles and fresh investment strategies. In adorning the wall with a new Gregorian calendar in 2018, we see only an evolution of current themesREAD MORE
Lessons from RBOHA
On 8 October, a large number of retail investors will breathe a sigh of relief, as they receive their principal of $900m back on what was New Zealand’s largest retail bond issue when launched ten years ago. It has been a bumpy ride for these investors. Many lessons have been learnt. In a world of low yields and interest rates, they will face one remaining question of how best to put their principal back to work to generate inc...READ MORE
RBNZ: Inflation, What Inflation?
At yesterday’s Monetary Policy Statement (MPS) release the Reserve Bank of New Zealand (RBNZ)
genuinely surprised financial markets, by assessing that the economic data received since February had a
neutral impact on the appropriate stance of monetary policy. While in the lead up many commentators
had focused on the recent jump in annual Consumer Price Index (CPI) inflation, the RBNZ’s response
could be summed up as “what infl...