By Roger J Kerr
The New Zealand interest yield curve is being forced lower again by a two-hit combination punch.
The flight of international capital to the safety and security of Government bonds since market volatility ratcheted up following the shock Brexit result has pushed long-term yields lower.
Longer dated NZ bonds and swaps have followed the 20 point drop in US 10-year Treasury bond yields to 1.45% after the Brexit result.
The demand for NZ Government, LGFA and corporate bonds by foreign investors has pushed the NZ dollar higher.
Most of the bond investors are from Asia and they want the exposure to the NZ dollar exchange rate (as a portfolio diversification) as well as the enhanced yield return.
The Trade Weighted Index (TWI) has appreciated 8% from 71.00 in January to 76.60 today.
Over the last nine months the RBNZ have constantly warned the markets that the NZ dollar is over-valued vis-à-vis our economic fundamentals (i.e. dairy commodity prices).
The latest bout of NZ dollar appreciation has not only come from the buying of offshore bond investors, it has also come from the RBNZ’s decisions in late April and early June not to cut the OCR.
The exchange rate is now so far above that RBNZ assumed level for their inflation forecasts that they have to be forced to reduce short-term interest rates at the next opportunity on 11 August.
If they do not take action to reduce the exchange rate, inflation remains outside their target band for a prolonged period (in breach of their mandate) and the export economy suffers, reducing GDP growth.
The reluctance from the RBNZ in recent months to cut the OCR again stems from house prices surging higher again in March/April, which was totally contrary to their earlier forecasts.
Hastier implementation of further macro-prudential controls on bank lending is what is needed from the RBNZ to address the financial stability risks in the residential property market, not allowing the correct monetary policy decisions (i.e. OCR cuts) to be blocked by the housing situation.
The local moneymarket shifted the pricing of an 11 August 0.25% cut to the OCR to 75% probability immediately following the Brexit result, however that pricing has eased back to a 50% chance today.
Lower short-term interest rates seem likely to follow the lower long-term rates, however it requires the RBNZ to move past their latest fears about the housing market.
A stronger US dollar on the global stage would help the RBNZ’s cause at this time, however event risks like the Brexit vote have meant that the US Federal Reserve are even more on the “go slow” with interest rate increases.
The USD Index has lifted from 93 to 96, however that has not resulted in a lower NZD/USD exchange rate at this stage.
It will take two or three months of consistently stronger US economic data to convince Janet Yellen at the Fed that another 0.25% interest rate increase is needed this year on top of last December’s first hike.
Stronger US manufacturing data over the weekend is a good start and this Friday night’s employment figures (180,000 increase forecast) may add to that positive tone.
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Roger J Kerr contracts to PwC in the treasury advisory area. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com
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