Here are the key things you need to know before you leave work today (or if you already work from home, before you shutdown your laptop).
MORTGAGE RATE CHANGES
Unity Money and ICBC both raised fixed rates today.
TERM DEPOSIT RATE CHANGES
Kiwibank raised its term deposit rates today, but none are market-leading although their 6 month 3.85% is better than any other main bank, and their 1 year rate is now 4.60% and also better than any big Aussie bank.
COMMODITY PRICES FELL
Commodity prices fell again in world price terms, but the basically held unchanged in NZD terms in October because the NZD fell in that month. Falling shipping costs helped. Meat prices fell sharply in the month, dropping -5.8% overall. Lamb prices fell the most (-7.1%) while beef (-5.2%) and wool (-2.9%) also dropped. Lamb is being impacted by weaker economic conditions in Europe and China, the main markets for this product. Beef pricing is being pushed down due to plentiful supply in the US as drought conditions result in more cattle being culled than normal.
ACCESSING ANOTHER LARGE MARKET
a2 shares (ATM, #9) jumped about +7% after the company said the US Food and Drug Administration has approved a2's application to send infant milk formula products into the US market. Synlait (SML #32), their supplier, got a bounce as well.
SOLID DEMAND, BUT LOWER YIELDS
There was another well-supported NZGB bond tender today with $400 mln offered and attracting $821 mln in bids. The $200 mln May 2028 went to 24 of 44 bidders at 4.57% which was less than the 4.75% two weeks ago. The $150 mln April 2033 went to 9 of 45 bids at an average yield of 4.44% which was also less than the 4.80% at the prior equivalent tender a month ago. The final $50 mln attracted $81 mln in bids from 24 bidders and was won by 12 of them at an average of 4.80% pa, down from 5.05% a month ago.
WE'LL NEED MUCH MORE OF IT
New Zealand is entering a period which will require substantial and bold investments across a range of sectors, from building more renewable energy sources to support the pursuit of net zero targets to development of technology sectors. KPMG has released new analysis of the flows of foreign direct investment coming into New Zealand to provide an overview of recent trends. Between 2013 and 2021, foreign direct investment has grown. The US and Australia are still the main sources of gross foreign direct investment, when measured over the last three years. Transaction activity was strong through the pandemic post the initial outbreak, as evidenced by high levels of M&A activity in 2021.
CONTINUING GIANT SURPLUSES
Australia recorded a +AU$12.2 bln goods and services trade surplus in September, up +AU$3.8 bln from August and up +AU$2.2 bln from the same month a year ago. It isn't their best month ever, but is the fifth month in the last 12 where the surplus has exceeded +AU$12 bln. Surging mining exports drove this result, of course.
SWAP RATES FIRMER
Wholesale swap rates may possibly be firmer again. NZGB yields certainly are again. Our chart will record the final positions. The 90 day bank bill rate is up another +1 bp at 4.17%. The Australian 10 year bond yield is now at 3.90% and up +15 bps. The China 10 year bond rate is unchanged at 2.69%. The NZ Government 10 year bond rate is now at 4.58%, and up another +19 bps from this time yesterday and now just above RBNZ fix for the NZGB 10 year which was up +25 bps at 4.56%. The UST 10 year is now at 4.12% and up +10 bps from this time yesterday and all due to the US Fed signals.
EQUITIES FALLING
In New York, after the US Fed announcement, markets cheered and rose on the basis that the Fed seemed to be easing off its rate hike program. Then commonsense kicked in. Shifting from +75 bps hikes to +50 bps hikes still means aggressive hiking. Equities then packed a sad, diving -2.5% to end the day for the S&P500. The Dow fell -1.6% while the tech-heavy Nasdaq dived -3.4% on the same realisation. Tokyo is closed for a public holiday (Culture Day). Hong Kong closed early yesterday on a Typhoon warning but is back open today, opening down -1.7%. Shanghai has opened -0.7% lower. The ASX200 is down -1.9% in afternoon trade. The NZX50 is down -0.8% in late trade.
GOLD LOWER
In early Asian trade, gold is at US$1639/oz and down -US$11 from this time yesterday.
NZD SOFTISH
The Kiwi dollar is a little softer at 58.2 USc. Against the AUD we are firmer than this time yesterday at 91.7 AUc. Against the euro we unchanged at 59.2 euro cents. That all means our TWI-5 is at 68.9 and a -20 bps slip.
BITCOIN SLIPS
Bitcoin is lower today, now at US$20,201 and down -1.5% from this time yesterday. Volatility over the past 24 hours has been modest at just under +/- 1.8%.
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72 Comments
Thanks for making stuff up out of thin air IO. Why do you have a problem with me changing my view of the economy late last year? I think many circumstances have changed and I have adapted my view, until late 2021 I was bullish, since then I'm becoming more and more bearish. Get over it.
Holding a belief about an overall approach to commerce doesn't preclude someone from identifying adverse market conditions.
This is generally a fairly unpredictable environment at the moment, so anyone making any serious financial moves will want to be increasing their margins or be well funded. Some schools would actually promote being prepared for such environments.
I think many circumstances have changed and I have adapted my view, until late 2021 I was bullish, since then I've becoming more and more bearish. If/when economic indicators improve in a few/many years, I'll be bullish again, I don't see a problem with adapting my views to changing circumstances.
Lamb prices should be at their peak for the European Xmas chilled trade, sea freight for which is now getting towards closing off. It is of course a great product but pricey to go with it. Sounds like though there is consumer resistance to those prices which will be belt tightening for obvious reasons. It’s a worry though, this a trade period vital for good revenue.
We manufacture a piece of farm equipment used by sheep farmers, have had the business for nearly 22yrs, we ride the ups and downs of sheep meat prices, sheep and beef farmers have had a really good run for many years.
A leg of lamb here has been up to $40, too expensive for the average household.
I just avoid lamb. Will do so again this Xmas even though it is my favourite meat and had become something I look forward to.
$50 for a single piece of bone-in of not-quite-export quality with a decent amount of fat removal required to get the taste of the meat coming through is really not something I can justify. Incredible to think that when I grew up, this used to be the default Sunday family roast.
KPMG has released new analysis of the flows of foreign direct investment coming into New Zealand to provide an overview of recent trends. Between 2013 and 2021, foreign direct investment has grown.
Does Foreign Direct Investment Generate Economic Growth? A New Empirical Approach Applied to Spain
It is often asserted with confidence that foreign direct investment (FDI) is beneficial for economic growth in the host economy. Empirical evidence has been mixed, and there remain gaps in the literature. The majority of FDI has been directed at developed countries. Single-country studies are needed, due to the heterogeneous relationship between FDI and growth, and because the impact of FDI on growth is said to be largest in open, advanced developed countries with an educated workforce and developed financial markets (although research has focused on developing countries). We fill these gaps with an improved empirical methodology to check whether FDI has enhanced growth in Spain, one of the largest receivers of FDI, whose gross domestic product growth was above average but has escaped scrutiny. During the observation period 1984–2010, FDI rose significantly, and Spain offered ideal conditions for FDI to unfold its hypothesized positive effects on growth. We run a horse race between various potential explanatory variables, including the neglected role of bank credit for the real economy. The results are robust and clear: The favorable Spanish circumstances yield no evidence for FDI to stimulate economic growth. The Spanish EU and euro entry are also found to have had no positive effect on growth. The findings call for a fundamental rethinking of methodology in economics.
This afternoon I thought I would investigate the following statement:
"the increase in interest rates would be covered by the increase in rents"
So I ran the numbers on this in excel using a Net Present Value of cash flows model.
If your investment property starts with an initial rental income of $30,000 (for example..) and it increases at 8% inflation a year and the lending is arranged for a 20 year term (for example), if the discount rate applied to this is investment is 3% (i.e. say current lending rate), the Net Present Value of the cash flows is $948,395. Roughly the average house price in NZ.
If the discount rate increases to 8% as the banks run the new stress test rate, this reduces to $555,555.
So even though your income on the property is increasing at the rate of inflation, the higher discount rate erodes this, and the value of the asset drops by around 40%.
I can see why the banks are getting nervous around lending in this environment.
What it could also mean, is that unless interest rates drop soon, the crash has already happened based upon the numbers, but it isn't visible yet as it takes time for the market to adjust to the new financial conditions. Unless conditions change, there are people in the system holding bad debt that is soon going to get exposed i.e. unless inflation and interest rates drop, we're playing a game of hot potato with bad debt.
Also to expand on this, if to contain 8% inflation, mortgage rates go up to:
10% - then the NPV of the cash flows falls to $460,000
12% - $388,000
15% - $306,000
If mortgage rates peak roughly where they are now around 6% then the value of the cash flows falls to $680,000 - still a 30% decrease in price.
If you add inflation to the picture, the decrease in prices would easily turn into 40-45% in real terms, even in a relatively conservative scenario. The loss in value of the housing stock is going to reach epic proportions. It was all nothing more than a gigantic Ponzi anyway, and the next year or so will clearly reflect it.
Yes but who knows what the future may hold - central banks may pivot to reduce the discount rate or come up with another way of supporting the current system.
Although it would appear to me that the only options that they have at their disposal risk creating even more inflation.
Interesting that the ishares 20+ year treasury exchange traded fund (ticker TLT) has priced in this change of inflation/discount rate to that similar series of cash flows already and its down approx 45% this year.
So with that, you get the immediate market pricing - as opposed to real estate that takes time to catch up as mortgage holders move to the higher rates of interest.
Unlike their underlying instruments, bond ETFs do not have a maturity date.
I guess this makes the pricing different to the underlying coupon bearing bond instrument which has a defined maturity, generally less than 30 years.
Perpetual bonds are priced thus :
Present value = D / r
Where:
D = periodic coupon payment of the bond
r = discount rate applied to the bond
A discussion about perpetual pricing versus coupon bearing defined maturity bonds has arisen before on this discussion board which caused me to challenge the editor at the time.
You could compare the outcomes using the NZDM office formula: https://debtmanagement.treasury.govt.nz/sites/default/files/media/media… (Page 8 of 18)
On the run US Treasury securities details can be found here. Redemption value is normally par, $100.
You could try my bond calculator : www.omo.co.nz/NZ_BOND_CALCULATOR.xls
A bond ETF is just like a packaged bond portfolio managed against a benchmark which has a duration. Whilst the ETF has no set maturity itself, the underlying instruments have a duration at any point of time which changes from day to day (usually slightly), so I don't believe that you are correct here in terms of the calculations. Just use the portfolios duration.
Duration is not a pricing formula suitable to determine the discounted present value (purchase value) of a bond.
Fixed-Income ETFs: Understanding Duration
Still, duration provides a common framework for evaluating interest risk. In fact, duration is sometimes expressed in years. You can think of duration as the weighted average of all the cash flows from the bond over time; that is, all the coupons and the return of principal paid by the bond issuer to the investor.
For example, a duration of 4.3 means a bond's value will decrease 4.3 percent given a 1 percent increase in interest rates, and vice versa.
Yes duration is shorthand for determining change of value given change of interest rate, it is not the same as a DCF, but your view that a bond portfolio held as a ETF is therefore a perpetual is incorrect. Would the valuation of a 0-1 year bond ETF be the same as a 20+ year bond ETF.
Good points there Audaxes.
"Unlike their underlying instruments, bond ETFs do not have a maturity date."
I guess neither do the bank's mortgage book - it is just a continuation of new loans and maturing loans - perhaps similar to bonds in the ETF that are being bought to market and those that mature from the market. - but the cash flows for each bond issue are being discounted for 20+ years (for the TLT) as the inflation and interest rate environment changes and the real time pricing gives an indication of the present value of those collective cash flows.
It is possible it's not representative at all - but it is the closest real time pricing asset I could think of to compare to a 20 + year mortgage where it will take time for the impact of the change to the discount rate being applied to expected future cash flows to be revealed to everyone in the market.
Now you can price a NZ twenty year government bond with the same YTM price changes you employed in your original examples. My calculator formulas work for real time trading. Certainly with ANZ's institutional trading desk in past times.
The interest rate risk management function of a large NZ mortgage bank's book is beyond my knowledge. In my own time in London the bank employed a warehouse risk manager to real time mark to market the book and employ duration/convexity analysis to manage the trading room US Treasury portfolio risk. Basis adjusted cheapest to deliver futures contracts were the hedge of choice. My job was to buy low, sell high and/or short sell high to buy low. Easier said than done.
" the crash has already happened based upon the numbers, but it isn't visible yet as it takes time for the market to adjust to the new financial conditions".
Exactly right, the only reason why this is not visible yet is that the housing market is not as liquid as other markets, therefore it is slower in reflecting the new reality. Moreover, there is significant upside risks to the OCR peak level, given the tardiness of the RBNZ in tightening monetary conditions. The only result of their softy softy approach to OCR raises will be a higher OCR peak than otherwise necessary. This is what happens when we give the levers of the NZ economy to incompetent muppets, both in Government and at the helm of the RBNZ.
Yes the ishares 20+ year treasury ETF gives more immediate feedback of the pricing of a similar series of cash flows with the changes occurring in discount rates.
Down about 45% so far.
iShares 20+ Year Treasury Bond ETF (TLT) Stock Price, News, Quote & History - Yahoo Finance
Those long term swaps have turned back up strongly again the last 2 days. Kiwibank looks like they dont want any long term retail funding going by their new TD rates today, the 4 and 5 year well below the market. I would have thought the banks would be looking to sure up their 3 to 10 year book ofter RBNZs statement yesterday.
North Korea seems determined to celebrate Guy Fawkes early this year by launching missiles ... Begs the question. Whats RE worth if war breaks out in the Pacific ?. Tackling inflation might be tougher than the RB ever thought. Have we blinded ourselves to a potentially severe threat? Hard not to notice the Ozzies are getting B52's and already have a few B2 Stealths ,F35's... We come in peace... I guess that will stave them off.... apologies for the distraction.
If houses become less affordable would it be fair to say they have in a sense become more expensive?
For example if house prices stayed the same but borrowing costs went down then houses become less expensive. Yet we observed that lowered borrowing costs caused house prices to inflate. Increased borrowing costs should cause house prices to deflate all things being equal. If they don't deflate then in a sense the bubble is continuing to inflate.
...just thinking out loud...
Interest rates could go up and a stall rather than a decline in house prices could be viewed as houses continuing on their inflationary trajectory. A restricted supply could work this way. It's not necessarily certain that house prices would go down. If their natural propensity was to double in price every ten years then that pressure should still be there but just suppressed by higher interest rates. Higher interest rates haven't punctured the bubble they have put a steel band around it.
The cognitive dissonance must be a real headache ZS when decades of confirmation and recency bias suddenly no longer appear to make any sense.
House prices must double every 10 years!
$2,000,000 average by 2030 with FHBs taking on $1,600,000 mortgages at 8% interest rates! $128,000 in interest alone annually before paying any principal.
Possible in nominal terms but if true, inflation is going to be far bigger issue than what we expect, and wages will need to more than double to make it work.
For sustainable house prices, the real price should barely change. In some ways this would be the effect of DTI. As wages rose, prices would adjust accordingly.
For house prices to rise 7% nominally, that 7% needs to be offset elsewhere otherwise the housing market is consuming a greater and greater portion of the economy as a whole. Until it’s an all consuming beast and the slightest hint of inflation would send it tumbling.
Theres no more money for it. It all dried up overnight. People gotta eat, houses aren’t going anywhere.
You’re still completely missing the point of my post/s. Will further simplify.
A number (house prices) 10x the size of a smaller number (incomes) both cannot both sustainably grow at 7% when the price of one is valued by the other. The smaller number will need to grow far faster than the bigger number to make this possible if the discount rate that is used to price the asset increases. It’s only been possible in your adult life by falling mortgage rates. It doesn’t work if mortgage rates regulate or rise over the long term.
I’ve come to the realisation (again) that a 40 year bond bubble and falling interest rates has destroyed peoples ability to think rationally about asset pricing.
I wish I could @pragmatist.
The required 7% wage inflation is a net calculation. That is 7% more dollars in the pocket to service the debt (And 7% more deposit). Due to the progressive tax system, you’d need more than 7% increase to cover it.
e.g if you’re earning 100k, you’ll need an 8% pay rise to get 7% increase in net pay.
Provided that interest rate changes weren’t at play.
Seems to me that the outsized capital gains on property are mostly the result of the discount rate continually dropping for the last 35 years...(and direct manipulation from QE in the last 14 years)
Eg what specuvestors are essentially doing (without realising it) is leveraging huge amounts of money and betting by proxy on the bond market, that is to say the denominator in the equation has had the largest impact on pricing because the nominator has not changed at the same rate (stagnant wages etc).
It should be noted a discount rate change from 2-3% has a far greater change in price than a change in discount rate of 8-9%
Serviceability is reported as being harder for FHB now than last year once the price drops and interest rate increases are factored in. That is in some way, as you say, more expensive. There’s still a lot of downward pressure in the market with interest rates going up, and affordability “getting worse”. Interest rates have a stranglehold on the credit needed to fund the market.
If prices stall and interest rates are still going up then chances are inflation is still present and the real price is going down still. Though indicate there is some support in the market. It’s hard to tell where that price point may be. Part of discovery.
Finally, a lot of the previous ~15 years housing pressure has come from lack of supply and highly competitive investors pricing owners out of the market. Though see IOs post above as to how the numbers just aren’t adding up for investment right this minute. And supply seems to be coming onto the market, a few days ago interest had a column on Auckland housing supply clearing the shortage this year.
Yes so it’s unfortunate that disorderly financial flows have gotten us into this mess. And a return to orderly financial flows needs to be so painful.
We’ve been privy to a live action of Hansel and Gretel played out over several decades. Now Orr is locking us away. He may end up getting burnt, but there’s a moral to all of this.
Are you confusing house affordability with debt affordability, as this site has been doing for many years per their home affordability reports?
"Lowering borrowing costs caused house prices to inflate"... Economics 101, too much debt money chasing too few houses and the expert economists at the RBNZ couldn't foresee this. The expert bank economists saw it, it's their business model and they also hold all the power in their puppet strings. Note the blame game the last couple of years.
Reality was it was never a shortage of houses but too many competitors in the market...
There was a shortage of houses due to high immigration. Housing affordability is a factor no matter how much you protest. Debt is an integral component of the economy. We saw house price inflation due to low borrowing costs. A fair amount of the potential of house price inflation is now being absorbed by borrowing costs. House prices will also continue to stay high due to general inflation.
General inflation (I assume you mean CPI inflation or wage inflation?) is eating away at house prices.
Imagine a scenario where everybody gets paid $3pw.
1/3 is taxed, $1 for food/bills and $1 for housing.
A year later food/bills cost twice as much, and wages rise to meet the extra cost. Everybody gets $4.5pw. 1/3 is taxed, $2 for food/bills, $1 for housing.
The real cost of housing has dropped, the equivalent cost to when everyone earned $3pw, is 67c towards housing. 33% drop in value.
Now add in interest rates which have doubled 3% to 6%. $1pw used to get $520 debt, now gets $360, reducing FHB buying power from being able to afford a $650 home to $490 home (factoring in 20% deposit in both scenarios). And that $490 is now worth 33% less than is was a year ago.
If houses kept up with inflation, that house would be priced double, requiring $6pw wages and the real value of the home would remain unchanged.
So, where is the money coming from that will keep house values so high?
I have been following Grantham for a while. Suggests holding cash, as I have been doing since late last year:
https://markets.businessinsider.com/news/stocks/jeremy-grantham-stock-m…
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