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Roger J Kerr scrutinises what the actual risks are to the economy - and the probability of them occurring

Bonds
Roger J Kerr scrutinises what the actual risks are to the economy - and the probability of them occurring
16th Nov 15, 10:29am by Roger J Kerr

By Roger J Kerr

There are a stack of things one could worry about in respect to the future direction of the NZ economy.

However, a strong belief that all the worst case-scenarios could happen at once and send our economy into deep recession is just not reality or responsible risk management.

Scoring the probability of occurrence of each potential risk is a more sensible approach and this is what the RBNZ will be thinking hard about in the lead up to their crucial 10 December Monetary Policy Statement.

The RBNZ is charged with the responsibility of forecasting the track of the NZ economy and the inflation rate so that they can adjust monetary policy settings well in advance.

How the RBNZ assign probabilities to the various risks over coming weeks will play a big part in determining whether they cut the OCR to 2.50%, or adopt a “wait and see” approach as opined last week.

My scoring of probability weightings of the risks actually occurring and eventuating into fact are as follows:-

  • The El Nino summer drought extending into the Waikato and substantially reducing agriculture productions and thus GDP growth. Probability of occurrence = 40%.
  • Wholemilk powder dairy prices returning to their record lows of US$1,500/MT. Probability of occurrence = 20%.
  • The Auckland residential property market boom rapidly turning into a nasty bust in 2016 due to panic reactions to tax, regulatory and banking changes. Probability of occurrence = 20%.
  • The NZ annual inflation rate increasing at a faster rate to higher levels than the RBNZ forecast over the next six months. Retailers will be increasing prices in early 2016 due to the lower currency value, however probably not above RBNZ expectations. Probability of occurrence = 20%.
  • The Chinese economy imploding and GDP growth slumping from +7% to +2%. Probability of occurrence = 10%.
  • Global sharemarkets plunging due to the Federal Reserve raising US interest rates in December and thus sending global investment sentiment down the tubes. The financial and investment markets have been factoring this change in for months so it cannot be a surprise, therefore probability of occurrence = 10%.

One would have to be a perma-bear pessimist to consider that all these risks will drag the NZ economy down against the massive positives of expansion continuing in the tourism, construction, manufacturing, retail and services sectors.

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Roger J Kerr is a partner at PwC. 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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28 Comments

by  Country boy  |  16th Nov 15, 10:55am 1447624540

Interesting Roger - I think you way underestimate the risk of El Nino on production (according to met service over 90% probability) and overstate the positives from tourism and manufacturing. As a result you remain too possitive by my lights. A close consideration of the export stats could right that for you. Note also the weakening in the housing permits in Auckland.

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by  Andrewj  |  16th Nov 15, 11:23am 1447626228

It's bloody wet in Hawkes Bay, I have feed going to waste.

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by  Country boy  |  16th Nov 15, 12:05pm 1447628753

Thats great - long may it continue. very dry in the Waikato but good rain today!

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by  Andrewj  |  16th Nov 15, 12:17pm 1447629449

We are having a very wet drought.

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by  Country boy  |  16th Nov 15, 12:53pm 1447631631

Don't count your chickens - El Nino hits in January generally. Suggest u prepare well.

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by  Andrewj  |  16th Nov 15, 12:55pm 1447631745

January won't be a problem, we always get dry them ,all the big cattle will have gone and I'll be at the beach.
However a few weeks of Nor-wester...

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by  Country boy  |  16th Nov 15, 1:03pm 1447632195

haha, Remember dry lasts to April - remember 87

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by  Ergophobia  |  16th Nov 15, 1:08pm 1447632488

Yes AJ, I'm on the NI East Coast at the mo and the hills are are lush and green, grass galore and the Croppers are happy too.

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by  Country boy  |  16th Nov 15, 1:59pm 1447635551

Guys it won't continue - Metservice and overseas met services are all calling an El Nino and putting very high odds on it (Some near 100%). North/east of NZ very dry - see the maps on met service. Have ordered supplement to sell to the overconfident. Always a lot in farming. take care. U wont see it til January. Current rain is no indication of anything except spring rains.

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by  Andrewj  |  16th Nov 15, 3:36pm 1447641410

Some El Nino events leave the East coast wet, not always a dry event for us. Also I don't buy in feed, I just lighten the load. I has been very cold, had a frost on Friday good enough for there still be ice on the ground at 10 am.
Growing degrees days way behind on the vineyard, over 30 days now.
I more worried watching the beef schedule fall, cow kill in NZ is up %70 and been a big Veal kill too. Also big cow kill in States
>>>
In New Zealand, on the other hand, cash flow issues are
having a significant impact on production. Dairy producers
continue to cull aggressively. In August and September,
combined heifer and dairy cow culling surpassed 2014 levels by more than 70%. Veal calf slaughter is also elevated which could limit industry regrowth when dairy
finances improve.
In the U.S., dairy producers slaughtered 59,234 head in the week ending October 31. This was up 8.2% from the same week a year ago, putting year-to-date slaughter up 4% from
last year after ten months. Dairy culling in Region 5, which includes Indiana, Michigan, Minnesota, Ohio and Wisconsin, has lagged 2014 volumes throughout the year, but in October
slaughter was nearly 5,000 head greater than last year.
Dairy producers in the Midwest have chosen an inopportune time to step up cull rates. Lean beef prices reached record highs earlier this year but they have been dropping hard since August. For the 21 days ending November 6, lean beef averaged $219.81/cwt., down $76.20 or 25.7% from a year
ago. The cattle futures market has been under pressure and incredibly volatile over the past few weeks. Cattle supplies remain tight, which argues that prices should remain high.
However, cattle feeders have been raising cattle to record heavy weights, which created a backlog of finished cattle and gave leverage to packers who pushed the markets
sharply lower

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by  Country boy  |  16th Nov 15, 4:25pm 1447644304

yes, there sure is a lot of uncertainty. Culled heavily here about 15% down this year and saw the production peak shaved 13%. Hoping to make it back with higher per cow production summer and autumn. Wonder when European milk production will fall away. Often my decisions to cull are poorly timed driven by feed necessity.

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by  Andrewj  |  16th Nov 15, 4:40pm 1447645225

Buyers’ pipelines are well filled and they have little urgency to bid prices higher. De-stocking must take place, and we expect that to be a gradual process. We look for prices to roll back further in the months ahead and stay relatively depressed, with some periodic fluctuations reflecting market uncertainty and strategic buying.
http://blog.usdec.org/usdairyexporter/global-dairy-market-rally-runs-ou…

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by  steven  |  16th Nov 15, 4:40pm 1447645241

yes it depends where you are, and even then....

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by  Simon  |  17th Nov 15, 10:08am 1447708080

I only did accountancy up to bursary level, and was only 15 when I did it, but I'm pretty sure a core concept in accountancy is that of conservatism. Where doubt or uncertainty exists err on the side of caution; the side that maximises expenses, future losses, and minimises revenues, future gains.

Guess by the time you're a chartered accountant and partner of a big firm the basics no longer apply?

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by  J.C.  |  16th Nov 15, 10:57am 1447624648

I assume that these probabilities are all intuitive and not based on any analytical framework.

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by  Triple  |  16th Nov 15, 11:12am 1447625546

Exactly!
I can make up some numbers too.

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by  skudiv  |  16th Nov 15, 11:43am 1447627424

Making up numbers is big business these days.......

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by  Basel Brush III  |  17th Nov 15, 9:18am 1447705105

Especially true by bank economists.

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by  skudiv  |  16th Nov 15, 11:43am 1447627383

We've already had 2 years of low dairy prices and unemployment is rising. House prices in Orcs are already falling, Chinese GDP I already sub 7% and they have had a massive SHX crash, so a few of your scenarios are already playing out, and somehow in your ivory tower the fog is so thick, you can't even see your own cataracts.

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by  notaneconomist  |  16th Nov 15, 12:15pm 1447629330

Roger you will have to ask which comes first the chicken or the egg!! You mention El Nino, WMP, Auckland house prices etc.......but if you are to do a proper risk management assessment then you would at least look at Government and bureaucratic spending and regulations these are the largest risks in any economy and I cannot for the life of me understand why so many people ignore the elephant in the room........

Any expansion in the economy is only happening because the Government and bureaucracy has policy in that direction...farmers worried about drought and WMP are going to be perma bears it is their livelihood on the line.....builders and tourist operators etc will be more bullish for they are in the right industry at the right time........the suit wearers just chase profits short and long just like politicians, bureaucrats and public servants....vampires of real production!

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by  Basel Brush III  |  17th Nov 15, 9:22am 1447705336

Government spending and attendant deficits are not bad per se.
What is bad is spending based on popularity polling which is what this Key government knows and does so well.

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by  notaneconomist  |  17th Nov 15, 3:02pm 1447725721

Hence even more reason not to allow Government spending........they won't be able to offer lollies if they don't have the means to buy them with!!

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by  xelnaga  |  16th Nov 15, 1:25pm 1447633523

The probability of one or two of those happening is decent.

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by  steven  |  16th Nov 15, 1:30pm 1447633825

You assume these are all not inter-linked.

"The Chinese economy imploding" ...which could then cause or be caused by,
"Global sharemarkets plunging due to the Federal Reserve raising US interest rates."

if the chinese economy does implode the demand for milk does what?
if teh sharemarkets slump the demand for milk does what?

also you state inflation but do not mention deflating as a quantifiable risk?

I assume then its zero? yet our tradeables are already -2% and even the non-trade seems to look like a downward trend?

If the above events happen deflation then has to be a real risk.

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by  linklater01  |  17th Nov 15, 7:32am 1447698737

I always enjoy Roger's musings and this is no exception.

His second paragraph is the classic strawman argument. I know of nobody who believes that there is a strong possibility of all the worst case scenarios happening,so that is just irrelevant.

I would love to see the evidence on which he bases his spuriously precise figure of 40% for the El Niño event.. It certainly doesn't square with what NIWA are telling us.

Bless him. He must be the only commentator who still believes the official Chinese growth figures. Would it be cruel to tell him that SantaClaus doesn't actually exist?

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by  Rumpole  |  17th Nov 15, 1:06pm 1447718764

I would rate Roger as follows -
General accuracy - 10%
El Nino - 1%
Milk Powder Price 90%
NZ Inflation 1%
China's true GDP 1%
Global Sharemarket Crash 50%
Picking relevant statistics - 90%
Understanding the relevance of the statistics 10%

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by  Doubtful Thomas  |  18th Nov 15, 9:36am 1447792619

Time to take off those rose tinted spectacles Roger. Everyone else has.

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by  Ms de Meanour  |  18th Nov 15, 10:34am 1447796057

Could Bernard please flag this article and the comments on it to be re-posted at the end of 2016?

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