Traders and economists are paring back expectations for how high interest rates will go after the spectacular collapse of Silicon Valley Bank and weak economic activity in December.
Just weeks ago, forecasters were mostly onboard with the Reserve Bank’s projections that it would lift the Official Cash Rate (OCR) another 75 basis points across its next three meetings.
Now, some think a 25 point increase in April will be the last of this cycle as the local economy teeters on the edge of recession and overseas regulators stabilize a handful of troubled banks.
The Reserve Bank (RBNZ) last month increased the OCR 50 basis points to 4.75%. It's now up 450 basis points since the current hiking cycle began in October 2021. In its February Monetary Policy Statement the RBNZ had the OCR peaking at 5.50% by December this year. The next OCR review is April 5.
Westpac NZ radically lowered its OCR forecast on Thursday, after being surprised by data showing weak economic activity in the last three months of 2022.
Acting chief economist Michael Gordon said the gross domestic product figure was a “major surprise to our understanding of the state of the economy”.
“The 0.6% drop in activity was weaker than both we and the market expected, and even more so once we take into account the downward revisions to growth in the previous quarters”.
This means economic activity was almost 2% weaker than the RBNZ thought when it released projections in February, and shouldn’t require as much restriction to bring inflation under control.
“We suspect that the December quarter was more of an air pocket during our descent, rather than an earlier and harder landing than the RBNZ was aiming for. Even so, the RBNZ will need to adjust its flight path accordingly”.
Gordon said the data prompted the Westpac research team to revise its cash rate peak to 5%, down from 5.5% previously.
“That implies only one more 25 basis point increase left in this cycle, which we still think will be delivered at the April OCR review”.
The April review doesn’t come with new forecasts or interest rate projections, meaning the central bank will be unlikely to reveal whether it has finished hiking until its meeting in May.
Traders had priced an OCR peak of 5.2% into overnight swap rates on Friday, down from 5.6% at the start of this week, suggesting serious doubts about future hikes.
Banked turn
Another reason financial markets have rapidly revised expectations has been the failure of Silicon Valley Bank - the 16th largest bank in the United States.
It collapsed largely due to the fast pace of interest rate increases, for which it had not hedged, which damaged the market value of the bonds it had been investing deposits into.
Some commentators think the US Federal Reserve continuing to raise rates would hinder its simultaneous efforts to restore confidence in the banking system.
Capital Economics, a macroeconomics analytics company, said in a note that bank failures such as Silicon Valley Bank were a warning that things can break when rates move too fast.
“This argues for policy makers moving more gradually on tightening from here,” it said.
Reuters reports US banks sought record amounts of emergency liquidity from the Federal Reserve over recent days following the failures of Silicon Valley Bank and Signature Bank. Banks took US$152.9 billion from the Fed's traditional lender-of-last resort facility known as the discount window, plus US$11.9 billion in loans from the Fed's newly created Bank Term Lending Program. The most taken from the discount window previously was US$112 billion in the autumn of 2008, Reuters says.
On Monday, US traders had priced in a Fed Funds Rate increase of about 70 basis points in the coming months. That has now almost halved to just 39 basis points.
ANZ Bank chief economist Sharon Zoller said NZ’s lower swap rates were largely following the declines in the US market.
“The correlation between daily rate moves in the US and NZ has long been higher than any macroeconomic links could justify,” she said in an email.
Several economists told interest.co.nz that traders were overestimating the monetary policy impacts of Silicon Valley Bank’s collapse in NZ, which has been broadly unaffected.
At the margin, the reminder that the global environment was volatile and risky might push the RBNZ towards a smaller rate hike - but was unlikely to put them off altogether.
“I don’t think it will be an easy decision to make, or for those of us on the outside to predict. But as Adrian Orr once said, if OCR moves are a no-brainer, then clearly rates are not where they need to be,” Zollner said.
ANZ economists have held onto their OCR forecast of two 25 basis points hikes in April and May to reach a peak of 5.25%. However, Zollner warned it was possible for inflation to linger and the OCR could end the year nearer to 6%.
BNZ’s research team has the same official forecast but senior economist Craig Ebert said the balance of risk was starting to shift to an even lesser peak.
“The recent warning signs from the international financial sector play to this - to the extent they suggest lower inflation pressure ahead, that is”.
Holding the OCR at 5% would provide some relief for mortgage payers, and could inject some confidence into the gloomy housing and equity markets.
68 Comments
The idea that interest rates will go drastically lower smacks of markets expectation that any instability will trigger central banks to start bailing out everything.
Was interesting to see the ECB basically ignore the markets pleas, and continue with 50 basis points.
TBH at this rate they don't have to go down, even a levelling off or pause will spur a huge amount of activity.
The fear comes from the rising of rates and the unknown, once that stops people make plans and push ahead with things.
If an elevated rate is now the new normal then there's not much to be gained by deferring as actual large-scale drops are surely unlikely, unless there is some sudden and massive downturn like a banking or pension fund liquidiity crisis.
But that probably won't happen. Again. This week. I mean it's Friday. So 50/50 at worst. Or at best. Maybe at best.
"rate they don't have to go down, even a levelling off or pause will spur a huge amount of activity."
I politely disagree with that statement. IMO, what hurts the pocket, and therefore spending, is how high the borrowing rates are and especially how much higher they are than 1-2 years ago. I don't see a "huge spur of activity" by keeping the rates where they are now, especially with the high amount of debt out there.
Do we know what % of the population owns most the debt, and of that debt what % is already rolled over to the higher rate. If both those numbers are high you are right. If they are low or mid % then there must be a lot of people who can and will spend again if it stops so it would have to keep rising and stay high?
Why did SBV fail?
Because interest rates had been too low for too long.
The RBNZ is fixing that at the local level, and still has a way to go. CPI is still above the OCR. If the next CPI reading is down to 2%, then today's OCR is at about the right level for that.
If you want to see what breakage is; what a broken economy looks like, then you'll get that opportunity if the RBNZ pause. The CPI isn't going to magically volt-face just because the OCR does. In fact, quite the opposite. Why? Because we still have a one-trick pony for an economic driver. And that, is spurred on by cheaper Debt.
(NB: The Cost of Debt doesn't fall when interest rates fall. Because we borrow more! Yes, what's happening now is unpleasant. But let's do it once, and do it right)
Our OCR is already the highest in the world.
I love it how by "world" you actually mean "the three-four Central Banks I happen to know the interest rates of". We're kinda in the middle and, yes, most higher rates are in less developed countries, but still...
Source: https://tradingeconomics.com/country-list/interest-rate
In 1970/80's they initially thought the same. Then came the great inflation and Interest Rates got up near 15/20% in some countries.
We can argue that conditions are different now.. and could argue either way - my logic is that just 18 months ago everyone thought silly low rates were here forever, that war in Europe was unthinkable, Germany thought their main gas pipeline from Russia would never be turned off, UK had inflation under 10% and there was no friction over decreasing supply of oil. Just 5 years ago who would have predicted a global pandemic and when covid started that houses would actually jump in value while we locked down, and then the floods and climate events globally, and ever increasing tension in russia/china/west. 10 years ago no brexit... the ist goes on. As a result there is definitely upside risk of more and very serious inflationary events (e.g taiwan war, a russia-us accidental direct engagement or expansion of the war or a chinese economic breakdown/split) AND more recessions and banking/business financial crises combine. And this is extremely hard for reserve banks to get right but they have to try.
I am kind definitely hedging my bets. However - IF the RBNZ is crazy enough to pause my money is definitely on sky high rates (the thinking is that there is plenty of money in NZ waiting to be spent by those that arent leveraged.. and as yet we havent seen unemployment and the GDP drop was fractional ... if things pause the under leveraged are going to take is as the top of the cycle and spend... once they start spending the habits are broken, prices rise again and then the RBNZ has to repeat the whole process. ). If they start to lose pressure on inflation and more inflationary events occur then we could easily find ourselves in mid to high double digit rates to get it under control and then in NZ we would may find ourselves living in a place resemling in many ways a third world country - for quite a while
We have a long way to go.
Yep it is clear that crises are becoming the norm, whether they be climate, health, financial or other and this is going to be destabilising, inflationary and a challenge for globalisation. Every year people sigh “Thank god that year is over, this year will be back to normal”, totally missing the point that this is our new normal.
Never let a good crisis go to waste. Better still, fabricate one. Big Pharma, US military complex, Central bankers all come to mind, but hey that's just a conspiracy theory, fed with a bunch of misinformation. Our new normal is a country living above it's means. Look around you. McMansions (consumption), one person per gas guzzling SUV's, council's out of control spending, government control of all industry, unneeded service industries like health and safety, traffic control, road inspection crews, environmental police, resource consent, it is like living in a giant penitentiary. And all with imported energy and cheap debt (for now). Globalization is over, the USA will exit the world stage and look after number 1. The military industrial complex will only be used for resource extraction they don't have at home. No enemies, lots of cheap energy and the best alluvial plain in the world.
Yep! Cut aggressively now and all work done to date come undone. We have higher wages than two to three years ago capable of servicing higher debts at those low rates. And what happens if those loans are drawn in droves and fresh new money is minted into the banks of the few? Right back to where we started tail end of 2021 within months in a world of pain, the nzd would tank against foreign currencies, out deficit would grow substantially and we’d be seen as an at risk country likely downgrading our credit rating and affecting future cash flows. We’d be back in this same position within two years with worse outcomes either side.
Can we shorten it to... The smart rich get richer while the dumb rich and everyone else get poorer again? All the while the middle class shrinks further into oblivion. If we think continuously widening the gap is good for anyone then we are mistaken.
What you say is very true. The point I'm bringing up is that it saddens me that property, homes... where we live and make memories... are utilised so heavily to create personal gain for a few. There are much more productive and beneficial ways to invest. Unfortunately I can't entirely blame those that do invest in property because it has always been setup to create relatively consistent and leverageable gains.
No government to date has found the right balance. Sure they've all talked a big game, especially our red friends, but what follows are toothless policies that in time are adjusted to, costs are transferred to consumers and the game continues.
So we're excusing bad fund management and blaming the FED? Let's not blame the basic mechanics of it all. They overleveraged themselves and got caught with their pants down. To not consider the chance of rates rising as they have, from where they were, and calculating that into their risk is not the fault of the FED. Provincial banks are not subject to the same criteria (enforced by government) as the larger city banks thus human error is more likely at the provincial level. The people who invested their money in that bank are also partly to blame as they we're chasing better returns at a higher risk.
Rates were just as low here too and rose even faster. How many banks have failed? 0.
Yup. I think the govt will formally have to change the RBNZ's CPI mandate for OCR rates to stop rising. The RBNZ's core mandate is price stability.
I think the bank economists are talking their books. They are worried that another round of OCR rises will cause house prices to fall another 10-20% which will lead to foreclosures.
If the overseas contagion does not spread in any significant way to NZ, and therefore not pose a risk to financial stability, I see no rationale as to why the RBNZ should not hike at least 2-3 more times.
Inflation is still high and unemployment ultra-low.
If the Fed pause or even cut, and the RBNZ keeps hiking, that will strengthen the dollar and help with imported inflation.
Im sure you understand that both "inflation" and interest rates are determined by the worlds major markets and NZ is not one...WHEN the Fed realises they must save the system we will be only too eager to follow suit...indeed we may even chance our arm and precede them.
Right central bank, treasury, and bank-funded economists. A quick lesson in macro:
Our economic engine runs on two sources of fuel:
- Net Bank Lending - the amount of money that banks create when they lend it out minus the amount of money that is destroyed when loans are repaid. This source of fuel depends on demand for new borrowing and (to a lesser extent) the willingness of banks to lend
- Net Govt Spending - the amount of money Govt creates when it spends minus the amount that is destroyed when taxes are paid. This source of fuel depends on Govt policy decisions
In the latter half of 2022 both sources of fuel basically stopped flowing. New mortgage and business borrowing collapsed (likely negative now) as interest rates moved up very quickly and house prices went into free fall. At the same time, Govt set about demonstrating their fiscal prudence - meaning that Govt spending is also currently net negative (more $ being taxed out of economy than $ put in).
This is a recipe for recession and rapidly rising unemployment unless you can somehow persuade all of the people that have stuck billions in their savings accounts to go on a spending spree. The return of tourism took up some of the slack in December and January, but as more disposable income starts to flow into mortgage payments over the coming months, and tourists disappear, we will be well into the doom loop.
The fact that economists are still waving charts around about productivity, tight labour markets, job vacancy levels etc just shows how blinkered they are - relying on theoretical models that are a world apart from how the economy really works. They are also using data that is months out of date. For example, did you know that median earnings have been falling in real terms for more than 6 months and have not changed in nominal terms since October? No? Funny that.
If RBNZ increases rates further in April they will be throwing water on a fire that went out 6 months ago and throwing tens of thousands of people out of work unnecessarily. My guess is they will move up by 25pts to save face - but that will still be a mistake.
As even China is about to find out, the economic reality facing us all is ...ageing and death. Employment stats will reflect this more each day. There will be over a million Kiwis living here over 65 in just a few years time. And our replacement Generation never materialised. It was unaffordable.
And as for Real Earning falling. We all know that. Especially the teachers and nurses. And they are part of the many to follow. It's too late to stop.
Why is all that happening? CPI got away on all of us. Transitory wasn't. And fear of extinguishing Inflation lest it kill the Debt Creation Cycle allowed it to get out of hand.
We have a choice. Bring it to heal now, or face far, far worse real wage deterioration.
OK doomer. As a society, we just need to ask and answer the big questions. Do we need to continue to import $20bn of oil and Teslas? Or would we be better off investing in green energy infrastructure and electric mass transit? Should we be stuffing billions into our kiwisaver funds 'for a rainy day' or should we be investing in top quality affordable housing suitable for older and younger people? Should we entertain a banking system that throws $7.5bn a year to overseas shareholders, or put structures in place to prevent thos earnings leaking offshore? My point (clumsily made) is that we have easily enough real resources in NZ to look after an ageing population - we might just need to stop swapping it for imported jetskis, teslas and petrol, etc, and start investing it in our future.
The performance of SVB is not a particularly good advert for capitalism either. Banks get the best of both worlds, they make massive profits and bonuses in the good times and in the bad times the governments step in with tax-payer money and bail them out. Why are we more comfortable giving hand-outs to corporates than we are to the people?
We're all dead in the long run.
More seriously, having an economic policy that prevents all the money and wealth ending up in the pockets of the top few per cent of the population is not 'socialism' - it's common sense. There is nothing more toxic for a country than inequality.
I agree with you, although I think you tend to slightly underestimate the impact of rising interest rates in quelling inflation. I agree it’s a crude and limited tool, but it does have some impact nonetheless. I agree that it’s potential downsides are large. It’s like a drug with only moderate effectiveness in treating symptoms but which generates bad side effects.
My point above should not be interpreted to imply that I think the RBNZ should raise the OCR further. Rather it’s what they probably should do given their mandate.
My own view, putting aside the real world constraint of their mandate, is they should pause / stop. The current OCR setting is going to whack the economy once it properly filters through over the next few months.
Ukraine War, economists: RBNZ might end OCR hikes...
Gabriel Cyclone, economists: RBNZ might end OCR hikes...
Overseas banking turbulence, economists: RBNZ might end OCR hikes...
Weak Local economy, economists: RBNZ might end....
RBNZ: "Weak local economy? We are purposely engineering a recession to fight inflation though.... "
Economists: "Fine, no more hiding our true intentions, we just want you guys to end OCR hiking cycle...
Darn it, just end it already..."
“The recent warning signs from the international financial sector play to this - to the extent they suggest lower inflation pressure ahead, that is”.
The far greater concern remains the steepness of the inversion. Curve currently prices a very quick transition from maybe one more rate, no real pause, then the near-immediate start of a rapid series of rate cuts. That's not SVB being the worst of it. https://youtube.com/watch?v=LhMS3B
Reuters reports US banks sought record amounts of emergency liquidity from the Federal Reserve over recent days following the failures of Silicon Valley Bank and Signature Bank. Banks took US$152.9 billion from the Fed's traditional lender-of-last resort facility known as the discount window, plus US$11.9 billion in loans from the Fed's newly created Bank Term Lending Program.
Section 2 - FRB H.4.1 statistical release
"Loans" category increased from $15.209 million last week to to $318.148 million this week.
I think the reason for having lower terminal rates is important here.
If it's because Q4 GDP is negative and expected to stay weak, then yes, mission partly accomplished.
If it's because some businesses or banks are struggling, then no, keep going with the rate hikes, for that's precisely the point of hiking rates.
Wishful thinking is from those who want interest rates to continue their upward trajectory when inflation is clearly under control. CPI has increased but this is much to do with extreme weather events. Growth has contracted if not stalled. It’s time for a pause, not a cut, a pause to wait for lagging indicators to give a clearer picture.
Anyone importing can tell you that many products are cheaper now than they were this time last year, due to much lower shipping rates and a better exchange. The lower prices may not feed through into NZ for a few months, as there is still high-priced inventory stock within the country to clear first. From what I can see imported inflation is well under control. Our food price inflation is high due to local weather events that cannot be influenced by interest rates. The bank should hold for now.
https://www.imf.org/-/media/Files/Publications/WEO/2023/Update/January/English/text.ashx
Some facts on declining growth and inflation.
We all need to understand that interest rates are not only driven by the OCR but also by the capital markets. Our enormous current account deficit of 8.9% of GDP requires us to seek a lot of overseas funding and those investors are requiring an increasing premium above our OCR. It also shows we are not able to create value added products from all those imports like the Swiss, Taiwanese, Dutch, Danish and so on. Our only economical achievement is that we are able to sell 11 bags of milk powder to the Chineses in stead of 10. Tourism will not come to the rescue because it becomes increasingly socially unacceptable to emit 3 - 5 tons of CO2 to get here.
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