Opinion: Lower for longer

By Roger J Kerr Forward pricing of 90-day interest rates and term swaps rates continues to decline in the marketplace as the realisation sinks in that the economic recovery this year will be slow and bumpy, allowing the RBNZ to take their time in respect to when they start lifting the OCR. The RBNZ have the luxury of time to wait and observe the economic developments through the first half of 2010 because the NZD/USD exchange rate still remains relatively high (and monetary policy tighter because of this) and banks are paying mile above the OCR for retail deposits, thus actual market interest rates are much higher than the official OCR and BKBM rate settings. Another good reason why the RBNZ are relaxed about the domestic economy and inflationary risks is that credit growth remains very subdued. They were starting to be worried late last year when the housing market picked-up, however that has fallen away again and credit growth remains very low. Given weaker employment, retail and housing data since the early December Monetary Policy Statement, the RBNZ have even more reasons to revert to their dovish tome of their October MPS on the economic forward look and reverse some of their more hawkish (and unnecessary) comments in the December MPS. If the next Monetary Policy Statement on 11 March reverts to a more dovish tone as we expect, market interest rates could come off another 20 to 30 basis points. While the NZD/USD exchange rate remains around 0.7000 the sentiment in the short-term interest rate market will remain "lower for longer" until either the exchange rate depreciates or the stronger economic data starts to come through. My view is that any improvement in NZ GDP growth this year relates heavily on the exchange rate coming off and exporting industries expanding and investing with some confidence again. Impact of the unwinding The wildcard for the RBNZ and other economic forecasters (therefore future inflation and monetary conditions) is just how the global economy recovers this year. The RBNZ rely on concensus forecasts for global economic and trading partner GDP growth forecast. There is very little concensus on anything these days, so it is a real crap-shoot as to what degree increased global GDP growth this year will feed into the NZ economy. What we do know is that all our export commodity prices are up, perhaps reflecting constrained future supply conditions than any confident commentary on global demand being strong. The commodity (and equity) markets have already built-in increased global consumer demand and GDP growth with their strong rallies upwards in prices last year. The debate continues as to whether these commodity price increases were reflecting expected real consumer demand or just the artificial and fickle type that comes with special monetary and fiscal stimulus put in place a year ago. As the PIMCO funds management investment professionals visiting NZ last week proffered, the global equity and commodity markets have not as yet priced-in the unwinding of monetary and fiscal stimulus. It is still a massive question as to how much underlying consumer spending strength will really be there once the stimulus of super low interest rates are removed. Put all this together and the RBNZ should be revising downwards their 2010 GDP growth forecasts and thus inflationary risks. The current trend in the market to price "lower for longer" seems very appropriate in light of this. "”"”"”"”"”- * Roger J Kerr runs Asia Pacific Risk Management. 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