Market not expecting OCR hike while housing, inflation and the strength of the NZ$ are likely to feature in the heavily scrutinised review

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The following is a summary of the key events impacting fixed income markets over the past week.

The Reserve Bank of New Zealand (RBNZ) releases its Official Cash Rate (OCR) review this week, which will be closely monitored by the market. While no change to the 2.50% OCR is expected, the press surrounding the possible introduction of the new macro-prudential tools increases.

OCR to remain at 2.50%

We, like everyone in the market expects no change to the OCR come Thursday, however as always, the commentary usually provides the clues to future rate rises or cuts. The market has already pushed interest rates higher with the yield curve steepening +11bp since the last RBNZ announcement on 13 June. Housing, inflation and the strength of the NZD are likely to feature in the brief but heavily scrutinised OCR review.

Housing still a hot topic

With the deadline for the macro-prudential submissions to the RBNZ well and truly now past, it is expected that by mid-August, the RBNZ will be ready to introduce these tools. This is most likely via a loan-to-value restriction, however the political pressure is increasing with Prime Minister John Key becoming more vocal in an attempt to exclude first home-buyers.

Inflation mix causing some concern

Inflation remains at 14-year lows (0.7% annual inflation), however the uneven mix between tradable and non-tradable is not a good sign that the RBNZ would like to see continue. Non-tradable inflation is the parts of the economy, which includes government and monopoly-style industries like electricity companies. This was once again evident with the largest positive contributor to the June inflation data being electricity prices, up +2.6%. There is little doubt the RBNZ would like to even up the scales going forward.

Ben Bernanke explains again

Fed Chairman, Ben Bernanke once again reiterated that an end to the Fed’s bond buying programme may go on for some time yet. Bernanke said the central bank’s asset purchases “are by no means on a preset course” such that “if the data is stronger than we expect, we will move more quickly” to reduce purchases. If data “don’t meet the kinds of expectations we have about where the economy’s going, then we would delay that process or potentially increase purchases for a time”.

Credit markets buoyed

The yield on the ANZ Investment Grade Bond Index fell -8bp over last week with other credit markets having similar rallies. Australian credit markets led the way with a -12bp tightening followed by Europe -8bp and the US -5bp tighter over last week.

The New Zealand yield curve flattened by -5bp as the 10-year swap rate fell -11bp over the week and the 1-year only falling -4bp. The New Zealand 10-year government bond continues to trade in line with US 10 –year Treasury. The benchmark New Zealand 10-year government bond yield fell -15bp.

RBNZ to review the OCR

So what has changed since June? The Reserve Bank of New Zealand (RBNZ) releases its Official Cash Rate (OCR) review on Thursday.

Of the 16 analyst forecasts on Bloomberg, only one has forecast the OCR to head higher in Q3 of 2013. It is a different story in Q1 of 2014 with 80% of the analysts picking the RBNZ to raise the OCR by +25bp.

If we look out even further, BNZ is the most bullish with an OCR of 4.0% by Q4 2014.

If we look back at the Monetary Policy Statement (MPS) released in June, where the RBNZ stated the OCR would remain unchanged through the remainder of 2013, we see there has not been any real change to the exchange rate (on a TWI basis) and inflation is even lower.

If we turn our attention to the RBNZ’s pet hate, the housing market, two recent indicators show the housing market is slowing or at least not growing as much as what is being hyped up by the media.

The RBNZ’s own data (experimental) of weekly loan approvals show a decline in the number of approvals and the lowest value of the approved loans since January 2012.

REINZ also published its house price index showing a decline in the month of June from 6.2% to 5.9%. While both of these figures may still be too high for the RBNZ, the slowing/declining trend is encouraging, however unlikely to stop the implementation of loan-to-value restrictions.

According to the RBNZ’s June MPS, the NZD is forecast to increase and since June the TWI is +1.8% higher and -1.4% against the USD. The RBNZ may be less concerned about the NZD that in previous policy meetings, due not only to being relatively stable in recent weeks, but the fact that the Fed may end its quantitative easing programme.

If the Fed signal the end of QEIII, then the USD is likely to strengthen (all things being equal).

Inflation (or lack thereof) continues to be a concern for the RBNZ with another record low reading in the June quarter. The Consumer Price Index (CPI) rose 0.7% year-on-year, the lowest reading since 1999.

Fig 1. Overnight Index Swap (OIS) Implied Rate Increases

Fig 2. Percentage Chance of 25bps OCR Hike

The above charts illustrate the current market pricing for a move in the OCR.

As they both highlight, the market is expecting a 25bp hike in the OCR at the March 2014 RBNZ meeting. The RBNZ itself (back in June) forecast no such move in the 90 day bank bill rate at least until June 2014 or even in September 2014.

The RBNZ does forecast inflation for Q3 to be significantly stronger at 0.6% (quarterly) which would see a move back  within the required 1% to 3% band.

So we would expect the RBNZ to continue with current form and highlight a move back into the middle of the band for inflation over the medium term. The RBNZ is sitting a lot more  comfortably than in previous months with underlying interest rates already higher, which in turn is likely to see higher mortgage rates flow through eventually to the borrower.

Corporate / Credit news

ASB raised NZ$525m via a floating rate note and a fixed rate bond. The floating rate note proved a touch more popular at NZ$275m, however both tranches were priced at 110bp over their relevant benchmarks. The July 2018 issue was predominately purchased by fund managers who took 65% of the issue.

Credit Agricole S.A. was downgraded by Fitch Ratings after the rating agency downgraded France’s credit rating from AAA to AA+ (stable). Credit Agricole S.A. received a one notch downgrade (A from A+) as Fitch considered the ability for the French government to support French banks decreased slightly. The BBB- credit rating of CASHA remains unchanged.

Detroit filed the largest-ever municipal bankruptcy in U.S. history last week, the once U.S. automotive industry epicenter may be up for a costly court battle with creditors. The bankruptcy (if approved) would mean creditors need to enter into negotiations with the city's Emergency Manager Kevyn Orr to resolve an estimated US$18.5bn in debt.

Insurance Australia Group (IAG) announced an upgrade of its insurance margin for FY13 from 12.5% - 14.5% to 16.8% to 17.2%. The upgrade was due to favourable impacts from natural peril, reserve release and credit spreads. Net earned premium for FY13 is expected to be A$8.3bn.

Motor Trade Finances (MTF) announced the confirmation of its banking facilities from Commonwealth Bank of Australia (CBA) and Westpac New Zealand Limited (Westpac), including extension of the expiry date to 30 August 2015, for its securitisation programme.

The US had its Aaa credit rating affirmed by Moody’s Investors Service and had its outlook improved from negative to stable. The outlook upgrade was due to the Federal government’s debt trajectory getting back on track.

Westpac (Australia) set the margin on its Basel III compliant tier two capital security. The margin was set at 2.30%, the lower end of the guidance range. WBC also took the liberty of increasing the offer size from A$750m to A$850m, however the bank has the ability to raise more or less.

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