Key developments
Globally, equity markets were weak over March, with most overseas markets down between 2-3% over the month.
After experiencing worries about rising inflation and the removal of monetary stimulus in January and February, in March equity investors were rattled by the Trump-led US government’s aggressive approach to trade negotiations and potential increased regulation of the technology sector. In addition, while the US Federal Reserve lifted the Fed Fund Rate to 1.75% as expected by markets, the so-called “dot plot” of projections showed the committee was split between expecting 3 or 4 hikes over the course of 2018. This underlined the Fed’s determination to continue removing stimulus, despite equity market wobbles.
After steadily rising through the end of 2017 and beginning of 2018, global bond yields fell around 10 basis points in March, following a re-emergence of risk aversion in response to recent equity market volatility. Indeed, the NZ 10-year government bond yield fell around 20 basis points to 2.75%, falling below the US 10-year yield for the first time since 1994.
On the back of falling bond yields, the best performing equity sectors were the bond yield proxies (utilities and real estate), while the worst were the more economic and market sensitive financial, materials and IT sectors. The New Zealand market returned -0.3% over the month, supported by a recovery in the stock prices of bond-sensitive stocks including Chorus, Meridian, Spark and Contact Energy. The Australian equity market fell -3.8% (in Australian dollar terms) on concerns the Royal Commission into banking practices would constrain bank profitability and declines in bulk commodity prices hitting the resources sector.
Source: Bloomberg.
What to watch
In the final week of March, Adrian Orr started as the new Governor of the RBNZ and signed a new 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, shifting the RBNZ away from the Governor being the sole-decision maker for setting the Official Cash Rate (OCR).[1]
Adrian Orr’s first Monetary Policy Statement (MPS) while in charge will be on 10 May, but before then expect a speech from the new Governor setting out his interpretation of the RBNZ’s role and objectives looking forward. We are expecting the OCR to remain on hold in the months ahead, not because of a new Governor or new PTA, but because inflation pressures remain subdued for now and more evidence will be required for the RBNZ to change its tune on the OCR remaining on hold for a considerable time.
Another area to monitor closely going forward is funding pressures, and particularly the rise in LIBOR/OIS spreads in global markets – a key indicator of funding pressure points.
Source: Bloomberg.
In the US money market, there has been a significant increase in the issuance of T-Bills as the US fiscal deficit has grown. At the same time, changes to money market fund rules have made it more expensive to issue US commercial paper. Many global companies and banks, including the big four Australian banks (ANZ, CBA, NAB and Westpac) use this market extensively for short-term funding. This tightening in funding conditions is flowing through to the hedging costs of borrowing in USD and swapping that borrowing back into Australian Dollars or New Zealand Dollars.
In response to these global funding pressures, there have been early signs of local bank funding costs rising marginally, as illustrated by ANZ issuing a 5-year bond at price of swap +100 basis points, when in December an equivalent security was issued at swap +75 basis points. If these global conditions were to persist or worsen, we would expect to see funding costs for the broader corporate sector also rising, which could ultimately put pressure on the equity prices of more highly-leveraged companies and sectors.
Market outlook
We continue to expect that long-term yields in New Zealand are biased modestly higher over the next 1-3 months, as interest rates normalise globally.
We have been cautious on credit for some time, partly because pricing was looking expensive, but also because of the effect, we expected from global funding markets tightening. We do think some value will reappear in markets, provided the global and domestic economies retain the reasonably healthy state that they are in at present. However, there are tail risk scenarios to manage. If, for instance, inflation rose quickly and central banks hiked more rapidly, pressures from higher rates would be felt more severely. While we do not yet see this as a base case, it may be prudent to retain a defensive approach, given the scope for downside if markets do deteriorate.
In equity markets, we see volatility increasing, and further technology disruption likely to be evident over the medium term.
Overall expectations for profit growth in New Zealand and Australia are modest in 2018. However, government policies and regulation in both countries are increasingly providing uncertainties in many industries. For instance, in New Zealand, we have a range of looming inquiries into, for example, the building industry, the telecom sector and the petrol market. In Australia, the Royal Commission on banking, superannuation and financial services is impacting sentiment in the financial sector.
Unlike the US, we do not see a pending change in official interest rates, either in NZ or Australia. In addition, we continue to be broadly constructive on global growth despite Trump’s announcements on tariffs. Our view is that the globally-oriented companies should continue to provide better investment opportunities compared with companies challenged by disruption, higher bond yields, or regulatory uncertainty.
[1] Harbour Navigator: “Banking Sector under the Spotlight”, https://www.harbourasset.co.nz/research-and-commentary/banking-sector-under-the-spotlight/
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