Wheeler cautions markets on over-reacting, US Fed remains on track for 2015 hike

Wheeler cautions markets on over-reacting, US Fed remains on track for 2015 hike

By Kymberly Martin

NZ swaps closed up 1-4 bps yesterday with a steeper curve.

Overnight, US 10-year yields pushed up from 2.25% to 2.29% ahead of the US FOMC meeting and have subsequently dipped back to 2.27%.

NZ rates initially pushed sharply higher following the speech by RBNZ’s Governor Wheeler yesterday morning.

Having left the door wide open to further rate cuts, at last week’s OCR Review, his key message this week seems, do not push this too far. He stated an aggressive cutting cycle would only be consistent with the economy falling into recession. Neither the RBNZ nor ourselves see that as likely at present.

Overall we are left comfortable with our core view the OCR will be cut to 2.50% by October, but no further. We see little to stop the RBNZ cutting in September, and see October as around a 60/40 call.

The RBNZ seemed keen not to overplay current low headline inflation. The Bank referred to core inflation being ‘”a bit’” below the mid-point of its target range i.e. 2%. It also spoke of recent declines in the NZ TWI feeding through to medium-term inflation, an issue we have highlighted.

The Bank reiterated that it now sees CPI inflation being close to target by H1 next year. We concur.

The RBNZ also made a timely reference to the ‘neutral’ cash rate. In recent months we have argued this needs further discussion. The Bank reiterated its analysis shows the neutral 90-day rate sits in the 4-5% range. However it is mulling this over. It says, the very low level of global rates could mean the effective neutral rate may be at the bottom end of, or below, this range. 

Our own OCR forecasts include a 4.25% cyclical peak in the OCR in 2018 (after first cutting to 2.50%). Implicit in these forecasts is the idea that the ‘neutral’ OCR may have fallen to 4.0% or lower. This will have implications for where borrowers perceive ‘value’ in the likes of 5-year swap rates. Yesterday, NZ 5-year swap closed 2 bps higher, at 3.21%, while 2-year closed at 2.94%.

The NZ 2-10s swap curve closed at 76 bps. We look to position for steepening from current levels, within a 70-125 bps range through to year-end.

Overnight, US yields pushed higher ahead of the US FOMC meeting in the early hours of this morning. In the Fed’s statement it repeated that risks to economy and jobs outlook were “nearly balanced”. The fact they are not yet deemed to be “balanced” suggested no urgency to raise rates.

The Fed is still looking for "some further improvements in the labour market" before it raises rates. Once again, it seems to require more evidence before hiking, although the word “some” is a new insertion. This probably implies the Fed feels it has already seen some improvement since its last meeting.

Overall, we believe the Fed remains on track to hike before the end of the year.

A September hike is still a possibility, but the Fed did not sound as if it was specifically setting the market up for this outcome. That the Fed’s tone confirmed it is in no hurry, initially helped US yields dip on the announcement. US 10-year yields fell toward 2.26% but now sit at 2.27% while 2-year sits at 0.70%. Fed fund futures price a 0.31% Fed funds rate by year-end from its current 0-0.25% range.


Kymberly Martin is on the BNZ Research team. All its research is available here.

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Implied but not directly stated, is that a "neutral rate" must be a moving target relative to other countries' rates, and to their perceived rate direction. This is largely because of the effect of relative interest rates on exchange rates, as demonstrated when Mr Wheeler finally conceded to point interest rates down a few months ago. A high exchange rate is contractionary monetary policy; a lower one is stimulatory to domestic production. So if our interest rates are 4-5%, and the rest of the world is close to zero, then that would be very contractionary, and likely disastrous for the current account. The neutral rate when global rates are zero, as we are seeing, is probably closer to 2%, especially when the terms of trade have turned down.
If and when the US gets up by say 1%, and maybe some others like the UK start to follow, then our neutral rate may lift by 50 to 100 basis points in conjunction.
Given current terms of trade, and our relative smallness, we should be followers, not leaders; and that really to me was the mistake of the RBNZ in heading up last year, fighting the power of the main global monetary currents, with damaging consequences for the exchange rate in particular. NZ is a relative cork on the ocean, and we need to go with the flow, not fight it.

...we need to go with the flow, not fight it.

Yes we do. The dairy industry needs to be pushed to ensure marginal producers are driven into bankruptcy or cut production, so supply and demand will realign at some point. Cutting interest rates to facilitate an extend and pretend regime is a farce of grand proportions.

Others note the same.

Prices haven't been helped by the news last week that New Zealand, the world's largest dairy exporter, had slashed interest rates, pushing its currency to a five-year low against the greenback.

A lower New Zealand currency means that farmers can endure lower global dairy prices before they have to cut herd numbers or reduce feeding, keeping milk supply ample. Read more - HT- Henry_Tull

don't you mean "marginal _processors_"

So can we name one country where they have successfully come out of the zero bound trap and put up and kept up interest rates? There seem to be some clear failures on that action ie Sweden and now NZ to name but two.

Add Australia to the list - they hiked continually in 2010/2011 - only to reverse them...

My view is that interest rates are a price transmission signal...
Just as price balances supply/demand ... interest rates should balance the dynamic between savers/borrowers..... ( between consuming today vs consuming tomorrow )
In todays Central Bank controlled world....we have all sorts of perversions...

Current acct deficits..... Malinvestment..... commodity price crashes... Asset Bubbles.... over consumption.... over capacity.... etc..

In our Central Bank controlled World we have completely lost sight of the natural role of interest rates.
The ... so called... neutral interest rate is a sign of sickness....
In NZ they said it was 4.5%... Well ..we could not even get to it in this business cycle..
Do u think we ever will..???.
We are a sick indebted economy.. ( each recession bringing lower rates )
AND... everyones quick fix answer seems to always be "lower interest rates"..
This is not a long term solution... its just a "fix".. ( a stimulatory credit drug fix..)
We are on an inevitable path....

It seems counterintuitive ... but in my view, financial repression does destroy capitalism...
the western Worlds version of a Monetary system.... with rampant credit growth over the last 40 yrs.... has made it so..

AND... everyones quick fix answer seems to always be "lower interest rates"..

It suits the book. I cannot fathom otherwise, when ANZ declares a NZD ~700 billion notional interest rate swap position while also loudly and relentlessly calling for lower interest rates - in addition to the NZD ~6.6 billion government, local body stock and bond position.

Monetary authorities and developed market central banks have each bought on the order of $5 trillion worth of assets for reasons that ultimately have nothing to do with earning an investment return on them. Regulatory pressures have caused pension funds, insurance companies, and banks to do likewise. While it is somewhat harder to put precise numbers to the size of these investments, it seems a safe bet that the total is in the trillions as well. Other investors are (pushed)... to also buy assets for reasons other than the expected returns those assets may deliver. To date, these investors have tended to be buyers, and given their lack of price-sensitivity, they have pushed up prices of assets beyond historically normal levels. At the same time, a natural buffer for many markets against a temporary imbalance between buyers and sellers, the dealer community has been forced to significantly curtail its activities due to the regulatory regime. So if circumstances cause these price-insensitive buyers to .... become price-insensitive sellers, there are not a lot of candidates to take the other side.


Neutral = 2%
And even that is on the high side.