Harbour Outlook: Elections, COVID waves come to the fore
At the time of writing, Joe Biden is poised to become the 46th US President of the United States, most likely presiding over a split congress. This likely outcome has broad implications for markets including less fiscal stimulus, decreased prospect of corporate tax hikes and more cohesive foreign policy.
Second COVID-19 infection waves in Europe have resulted in the reimposition of lockdowns which are likely to have a negative impact on economic activity.
High frequency New Zealand growth indicators have largely returned to pre-COVID levels since the country reverted to Level 1 in early October. However, the level of activity remains below pre-COVID levels.
The earnings season in the US painted the picture of a robust earnings recovery. At the time of writing, 417 companies have reported earnings with 84% of companies beating consensus earnings expectations.
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.
Harbour Outlook: Election, recovery and vaccine uncertainty
Joe Biden is a firming favourite to become the 46th US President. If Biden wins but the Republicans retain the Senate, most analysts predict little aggregate market reaction. At present, this outcome is finely balanced. A Democrat clean sweep is viewed as a less market-friendly outcome.
The easiest part of the economic recovery phase now appears to have passed. Investors are more likely to face waves of positive and negative data to anchor views. Economists have widely dispersed views on the near-term outlook for both the New Zealand and Australian economies.
Looking forward, announcements from many of the nine current COVID-19 vaccine Phase-3 trials are likely this quarter. Already markets have reacted to both positive and negative news, indicating the strong influence that the results have on uncertainty.
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
The world is learning to live with COVID-19 and economies are recovering faster than expected, demonstrated by, in aggregate, better-than-expected economic and earnings data in August.
With the US Federal Reserve (the Fed) moving to an average inflation target, the Reserve Bank of New Zealand (RBNZ) confirming it is on the same page as the Fed and the Reserve Bank of Australia stating it "will maintain highly accommodative settings as long as is required”, central bank policy is likely to stay accommodative for longer.
The dovish stance from the RBNZ has led to markets pricing the Official Cash Rate (OCR) at -0.20% in a years’ time.
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.
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
Better-than-expected economic data and company earnings have supported risk sentiment over the past month.
Continued progress towards a COVID-19 vaccine, alongside ongoing stimulus, has also added to the positive mood, outweighing concern about ongoing mobility restrictions and second waves of COVID-19 infection.
The New Zealand economy continues to benefit from ongoing control of COVID-19, low mobility restrictions and policy support. Fiscal stimulus is likely to wane and ongoing border closure means complete recovery is largely contingent on a vaccine.
