Dairy more important than houses

Bonds

Roger J Kerr says it's more important for the RBNZ to cut interest rates now and get the kiwi dollar down, rather than wait because of concern about the rising house market

26th Apr 16, 9:51am by Roger J Kerr

By Roger J Kerr

It is another situation of “will he, or won’t he cut interest rates?” this week as the markets anticipate the RBNZ’s OCR review on Thursday April 28.

Based solely on the exchange rate level and their consistency of messaging/actions the RBNZ should reduce the OCR to 2.00% this Thursday.

The local moneymarket’s pricing of interest rates is sitting at only a 30% chance of a 0.25% reduction with the banks becoming unnecessarily cautious as the March quarter’s CPI inflation result of +0.20% was above their forecasts.

The inflation increase, however, was bang in line with the RBNZ’s forecast and therefore the only thing that has changed from their early March signal that they would cut rates again is that the exchange rate has appreciated.

The rise in commodity prices and a weaker US dollar value over recent weeks has thwarted Governor Wheeler’s desire to push the NZ dollar lower so that he gets inflation back into the 1% to 3% band.

Since December the RBNZ have, rightly or wrongly, been perceived as too changeable with their monetary policy signaling and actions. Now is the time to show consistency and follow through on warnings made earlier.

The RBNZ stated in early March that they would cut the OCR again dependent on the economic data and subsequent financial market developments. The overall exchange rate value as measured by the TWI Index at 72.30 is significantly above the RBNZ’s assumed level of 68/69 to get the inflation outcomes they forecast.

Why would the RBNZ wait a few more months before cutting the official interest rates when the inflation outcome for the March quarter was in line with their forecasts and the currency is much higher?

In many respects reducing interest rates again at this time is the lesser of two evils as the subsequent decrease in mortgage lending interest rates will only pour more fuel onto the residential property market fire. The RBNZ should cut rates to get the NZD down to immediately assist the beleaguered dairy sector and hope that further macro-prudential measures and Government actions control the real estate bubble.

Governor Wheeler will know only too well that if he pontificates this week and does not cut the OCR, the NZ dollar will move back up above 0.7000 again and he will be under even more pressure and scrutiny with inflation staying below the 1% minimum for longer.

The RBNZ will be very conscious of the milksolids payout forecast for the new 2016/2017 dairy season being made at the end of May.

A third year of very low milk prices that produce negative cashflows and financial losses for dairy farmers is very negative and damaging for the economy. There is more immediate urgency for the RBNZ to address the exchange rate level for the dairy industry to avoid widespread receiverships/banking bad debts than holding interest rates at current levels to attempt to keep the housing market in check.

A lower NZD/USD exchange rate back to the mid 0.6000’s and improving wholemilk powder prices towards US$2,500/MT are crucial to restore the milksolids payout to above $5 for the dairy industry.

A recovery in the US dollar on global FX markets and a realisation in the bond market that Federal Reserve Janet Yellen may have gone too far with her over-cautiousness on US interest rate increases has lifted US 10-year Treasury Bond yields to 1.91% from 1.75%. Further increases over coming months seem likely as US economic data and inflation rates print on the stronger side and world financial/investment markets remain relatively stable.

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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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23 Comments

by Colin | 26th Apr 16, 10:35am 1461623754

Trying to clean up one bubble which has burst at the same time fueling another. We are going to ultimately pay dearly for the worlds central bankers monetary madness.

by Yvil | 26th Apr 16, 11:10am 1461625852

Well said Roger, I don't always agree with you but you are spot on

by MortgageBelt | 26th Apr 16, 11:30am 1461627031

"Based solely on the exchange rate level and their consistency of messaging/actions the RBNZ should reduce the OCR to 2.00% this Thursday." Agree.
The RB could also make an attempt to meet their PTA target. Maybe get the PTA document out and re-read it. Target = 2% inflation. Current inflation rate? For how long?

by Afewknowthetruth | 26th Apr 16, 11:57am 1461628668

There is no way within the current paradigm to fix the predicament the Key government has created. Neither raising interest rates nor lowering them will help at this late stage in the game.

The time to fix things was over 2007 to 2008, but central bankers and Wall Street were more concerned with keeping their games going a bit longer than with addressing anything fundamental.

The fuse is burning and cannot be extinguished. It's now just a matter of time before it all explodes (implodes). Until it does, there will plenty of people running around 'with their hair on fire'.

by Stephen Hulme | 26th Apr 16, 12:31pm 1461630701

Yes, indeed - what could possibly go wrong here?

While the Bank of Japan’s name is nowhere to be found in regulatory filings on major stock investors, the monetary authority’s exchange-traded fund purchases have made it a top 10 shareholder in about 90 percent of the Nikkei 225 Stock Average, according to estimates compiled by Bloomberg from public data. It’s now a major owner of more Japanese blue-chips than both BlackRock Inc., the world’s largest money manager, and Vanguard Group, which oversees more than $3 trillion. Read more

by Andrewj | 26th Apr 16, 1:49pm 1461635381

Lately I've been running on faith
What else can a poor boy do?
But my world will be right

https://www.youtube.com/watch?v=vtvUZikoenM

by David George | 26th Apr 16, 2:33pm 1461638024

Yes, quite incredible; the central banks are buying big corporations with fresh "money". Aside from the obvious question of where it will all end; what are the implications for small and start up businesses that aren't in line for this largess?
Add it up; we've now got multinationals avoiding taxes on a monumental scale, buying up any possible competition, twisting governments to their will, writing trade agreements, extending copyright and patent protection, dictating labour laws and beating down their suppliers. We all know how vital it is that there is a healthy competition from a growing small and medium enterprise sector with as little as possible in the way of barriers to entry yet, strangely, this sector is being kneecapped by deliberate policy. Very creepy these fascist tendencies.

by Rumpole | 26th Apr 16, 1:25pm 1461633906

Been awhile since I have agreed with you Roger but surely a 1% cut would wrong foot the market, burn speculators, crash the NZ$,improve export returns and re instate import substitution. To avoid more housing lending restrict it to 3-4 times income for self occupation, 10 times for investment and increase Bank reserves accordingly by changing risk weighting to investment, with offshore investment lending at a 50% weight. Look forward to credible response to identify the flaws.

by sharetrader | 26th Apr 16, 1:54pm 1461635693

god suggestions but wont happen,
too much self interest. why would MP's vote for 10 times on their rental houses,
second all the ex national MP's on the bank boards and in senior roles will lobby to make sure more capital is not carried

by Penguin | 26th Apr 16, 1:45pm 1461635106

Introducing the property tax and cutting interest rates at the same time seems the sensible solution.

by Brutus Iscariot | 26th Apr 16, 2:01pm 1461636099

Pfffft...dairy? Talk about having your eye on the wrong ball.

by zorro15 | 26th Apr 16, 2:20pm 1461637244

Has the cutting of interest rates lead to a lowering of the exchange rate recently, for a few days perhaps then it is back to where it was before. All that will happen is that deposits will reduce and more money will go into the Housing market. If we keep doing this we will end up like the zombie economies of Japan and Europe where borrowers pay less than depositors earn.

by Donker | 26th Apr 16, 3:09pm 1461640156

If people think a cut in the OCR is going to influence the dairy disaster, then it like pissing in the wind

by Mystery | 26th Apr 16, 4:28pm 1461644890

Peeing WITH the wind has a very different outcome to peeing AGAINST the wind. Cutting the OCR will definitely benefit the dairy sector. though who knows how long for. The effect on the exchange rate from the last OCR cut was very short lived as the USD temporarily "fell from grace" shortly after that. Thursday's OCR cut could be a repeat of that. :-I

by sharetrader | 26th Apr 16, 4:47pm 1461646056

very short term if your lucky one month my guess shorter.

by Grant A | 26th Apr 16, 8:26pm 1461659206

Roger - the history of the past recent years shows that cutting the OCR only guarantees one thing, a further crucifying of FHBs and a bigger and bigger housing bubble blown. The one thing its failed to do is to lower the NZ Dollar (the move from 0.80 odd to 0.60 odd was a USD move higher) and what move there has been has failed dismally to inflate tradeables inflation - sounds like a really stupid idea to keep doing the same thing and expecting a different result.

Of course we could always do more of it, just like the US and europe have done with QE, and dig an even bigger hole that those two continents will take forever to dig their way out of. Dairy will get out of its hole, and most will survive, without needing 1% OCRs to do it - what won't survive will be the equity of many many home owners if this bubble continues to be blown in pursuit of a dairy solution and inflation rates that no one globally can achieve currently and so is outside of our ability to generate it until suddenly we find we have it again which will happen - commodities do not sit this far below the cost of production without a big surprise to many at some point.

by Andrewj | 26th Apr 16, 8:36pm 1461659767

http://www.reuters.com/article/us-germany-economy-property-idUSKCN0XL0LG

by BadRobot | 26th Apr 16, 8:58pm 1461661134

If you read the article two things stand out - first borrowing is only 70 odd percent of the value of the property. Second they are talking of 2% interest rates for 15 years.

by ObeseBallerina | 26th Apr 16, 10:19pm 1461665962

One is already normal in NZ and soon the other will be too.

by BadRobot | 27th Apr 16, 5:14pm 1461734042

I doubt NZ will ever get to 15 year mortgages - our interest rates are too volatile. Up to five years is the norm.

by ObeseBallerina | 26th Apr 16, 8:43pm 1461660230

I agree Roger, the OCR MUST be in line with Europe, US and UK rates to drop the $. Why its taking so long Ill never know.

by BadRobot | 27th Apr 16, 5:18pm 1461734320

Why - you keep saying things like this - but provide no evidence or logic why except what appears to be your own self interest. Just because parts of the rest of the world have low interest rates doesn't mean New Zealand should or will.

by linklater01 | 28th Apr 16, 10:02am 1461794534

Do my eyes deceive me,or is this RK now demanding a cut in interest rates,the same RK who has consistently warned Against OCR cuts? Has he stopped believing in the veritable tsunami of inflation that would engulf us,were the Reserve Bank so foolish as to ignore him?
Welcome to the real world Roger,a world in which low growth and thusinterest rates, will be a fact of life for a good many years.
A leading American economist, Robert Gordon argues that economic growth will be weak for at least the next 20 years. The American economy,he believes has run into 4 'headwinds', demographics,education,inequality and government debt.the world is awash in debt and people like Draghi are seriously considering helicopter money.
So where does this leave the asset bubble of property and share values? My best guess is that the party is not yet over,But at some point,there will be a significant correction; at least 20% and probably more. Bring it on,I say.