By Roger J Kerr
Local economic analysts and commentators who think the Reserve Bank should slash NZ interest rates a lot further yet to 1.50% because the world economy is apparently on the brink of a deflationary/recessionary spiral down, may need to think again.
To be fair, some parts of the global economy have their problems with continuing deflation/no growth in Europe and oil/commodity producing economies such as Brazil and Russia sliding into recession. However, economic growth is reasonably robust and inflation far from dead in the US, China and Australia.
Inflation here in New Zealand, whilst very low on an annual basis due to the plummet in oil prices over the last 12 months, is not actually that benign as the March quarter’s CPI figures on 18 April will confirm. The upward pressure on our building costs should continue despite the slow up in residential re-build in Christchurch. Commercial and industrial construction activity levels in Auckland, Hamilton and Christchurch remain strong. On top of that major projects such as the Transmission Gully road in Wellington and the Sky City Convention Centre, Commercial Bay project and railway tunnel in central Auckland will further stretch resources in the construction sector.
Wage increases have been low to date due to inward migration numbers, lower mortgage rates and lower motoring costs for households reducing the need for pay increases. These favourable conditions for both employers and employees are unlikely to repeat over the next 12 months, therefore the labour market demand/supply equation will start to change.
Turmoil in global share markets in January caused safe-haven buying of US Treasury Bonds that forced a reduction in 10-year yields to 1.70%.
The US bond market has moved sideways over the last two months as the weight of cash sloshing around the world holds the yields at the lower levels.
It appears that only strong GDP growth and higher inflation in the US will prompt bond investors to reduce their buying and portfolio durations.
The US employment gains and manufacturing data for March were again impressive, which suggests that the argument that global risks could de-rail the US economic recovery is not so convincing.
It was expected that rising US short-term interest rates in 2016 would push Treasury bond yields up. To date this expected outcome has failed to materialise as Fed Chairwoman Janet Yellen appears overly cautious about global risks.
At some point over coming months the bond market should recognise that US economic trends are actually more important than worrying about whether the Chinese can maintain their 6.5% growth and bond yields should lift.
As we have stated many times over the last nine months, the Chinese have both fiscal and monetary policy leverage to ensure their economic growth achieves their 2016 target. The western markets should comprehend this by now as the Chinese have pulled these levers in August last year and again in January this year to settle and calm volatile global financial/investment markets.
Global economic risks continue to be overstated in my view and eventually the financial markets will reflect that risks have reduced since January.
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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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