Roger J Kerr says the current monetary policy settings are not changing any behaviour in the economy and thus are ineffective and impotent

Roger J Kerr says the current monetary policy settings are not changing any behaviour in the economy and thus are ineffective and impotent
RBNZ Governor Adrian Orr keeps pumping the cash. Illustration Ross Payne

Summary of key points: -

  • Downward correction in NZD/USD still playing out
  • Monetary policy transmission mechanisms being disrupted

Downward correction in NZD/USD still playing out

The central theme and medium-term currency market outlook of this column has been for a higher NZD/USD exchange rate for some time now (due to a paradigm change in the direction of the US dollar globally). However, over recent weeks we have been calling for a shot-term, but sizable, pullback in the Kiwi dollar from 0.6600/0.6700 to somewhere around 0.6400.

That corrective movement is now playing out in the FX markets with the NZD/USD rate trading in a volatile fashion to the low 0.6500’s, despite continued USD weakness against the major currencies.

On the technical/chart front the Kiwi staged a “key-day reversal” on 19 August when it jumped up one cent from 0.6550 to 0.6650, only to reverse immediately under sudden selling pressure to a low of 0.6490 within 24 hours of the 0.6650 peak.

The strong recovery in the NZD/USD rate from the Covid shutdown lows of 0.5500 in late March has maintained its upward momentum for nearly five months now, however the pullback in the Kiwi dollar we are now witnessing has seen the rate break below the uptrend line since March.  

Whilst local factors have largely caused the Kiwi dollar to be a serial under-performer compared to other currencies against the USD over recent weeks, the near-term outlook is more likely to be determined by where the EUR/USD exchange rate moves next.

The depreciation of the US dollar against the Euro over recent months has been startling, the USD plunging 8.5% from $1.1000 in early June to a high $1.1950 on 18 August.

The NZD has only appreciated 2% over that same time period from 0.6400 to 0.6540.

It appears to be another case of “too far, too fast” for the EUR/USD exchange rate and therefore a short-term recovery for the USD back to the $1.1600 area appears more likely than continuing USD depreciation to above $1.2000.

The EUR/USD rate has already dropped below $1.1800 as speculative market participants take profits on their short-sold USD positions.

On Wall Street, the tech stock valuations appear to be well over-hyped as retail investors rush anything that moves. A correction downwards in US equities over coming weeks would be positive for the USD short-term, and as always, negative for the Kiwi on the investor “risk-off” mode. The EUR/USD shift to $1.1600 would cause the Kiwi to move another cent lower into the low 0.6400’s.

However, the medium-term FX market view remains unchanged, looking into 2021 the likelihood of a significantly weaker USD against all currencies would result in the NZD/USD rate trading above 0.7000.

Monetary policy transmission mechanisms being disrupted

The partial shutdown of the Auckland economy (and knock-on negative impacts on other regions) due to the recent Covid infection re-outbreak and the RBNZ Monetary Policy Statement on 12 August have been the reasons behind the NZ dollar under-performance and downward correction.

Forward pricing in the NZ short-term interest rate swap market has turned negative since the RBNZ statement, for the first time ever.

The FX markets are reflecting that very pessimistic economic outlook (i.e. the interest rate markets are now saying that the RBNZ will have to implement negative interest rates sometime next year) and three local banks are now forecasting negative interest rates in 2021. Never mind that negative interest rates have not worked in stimulating the economies in Europe and Japan and the Aussies have ruled them out as being ineffective and therefore unnecessary.

Despite all the massive fiscal and monetary stimulus already put in place over recent months to pull the economy up from the Covid shutdown shock, the RBNZ and the markets are still saying that a lot more stimulus will be needed to prevent the economy going into a depression next year.

They are both “over-the-top” pessimistic on that outlook in the writer’s view.

The economy and the business community are far more resilient and adaptable than what is being portrayed here, as the better than expected rebound in retail, housing, manufacturing and export statistics have proven over recent months.

The RBNZ continue to confirm that they stand ready to implement further unconventional monetary tools over and above the cutting of the OCR interest rate to 0.25% and the QE money printing through the increased LSAP limit to $100 billion.

They are preparing for negative interest rates, direct/cheap term lending to banks to on-lend to borrowers and buying of offshore bonds.

The RBNZ will argue that they are just modelling the worst-case scenario and being prepared to act in advance.

However, in my opinion none of these measures will be needed and the current monetary policy settings are not changing any behaviour in the economy and thus are ineffective and impotent.

The cost of money (even at close to zero) is not making any difference in enticing borrowers to take on further debt and do stuff.

The transmission mechanism of lower interest rates stimulating increased investment (by business) is not working as business is reluctant to add debt, no matter what the cost, because of the uncertain future environment.

Even if a company wanted to increase their debt, they are still up against tightened-up bank lending and credit policies.

There was very little analysis of these transmission blockages in the recent RBNZ statement. The banks are awash with cash and seem hesitant on new lending.

The second transmission mechanism the RBNZ have with monetary policy is through the exchange rate.

They believe they have been successful in keeping a lid on the NZD/USD rate and keeping it lower than where it would otherwise be to help exporters.

As has been stated before in this column, the Kiwi could appreciate to above 0.7000 over the next 12 months and exporting companies’ profitability would not necessarily reduce as most have multi-year currency hedging in place.

The RBNZ appear to ignore the fact that exporters hedge their financial risks, the latest one being a substantially weaker USD globally, nothing to do with New Zealand.

The RBNZ are on a hiding to nothing in attempting to keep the NZD/USD exchange rate down (when it is not needed due to hedging) against the global forces of a paradigm shift in the value of the USD.

The RBNZ also want a lower NZ dollar value as, in their view, it helps them get inflation back up to 2% (imported goods more expensive).

The confident predictions from the RBNZ and bank economists that annual inflation in NZ is headed to zero are also at risk of being well wide of actual outcomes. Tradable inflation will be moving up over coming quarters, non-tradable inflation remains at +3% per annum and food prices are skyrocketing. Just saying!

The RBNZ will also argue that they are better to over-pump the monetary stimulus (and pull is back later if need be) than run the risk of no doing enough.

The potential problem with that is the unintended consequences of causing over-inflated asset bubbles through overly-easy money.

The US equites and residential real estate markets are showing classical signs of bubble conditions.

New Zealand is heading in the same direction with sharebrokers reporting money flooding into shares from investors they have not heard from in years.

Normal lifestyles cannot be funded from only a 2% yield return from bank deposits.

Distorted investment asset bubbles inevitably burst; it is just a question how badly they burst.


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*Roger J Kerr is Executive Chairman of Barrington Treasury Services NZ Limited. He has written commentaries on the NZ dollar since 1981.

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17 Comments

Have to agree with this statement; "the current monetary policy settings are not changing any behaviour in the economy and thus are ineffective and impotent." Particularly as the RBNZ Governor is even trying to help prop up the property market (how many investment properties does he own?). Until effective and robust regulation is introduced to manage and limit the private bank actions and behaviour virtually nothing else will be effective.

...... and to think, just a few years back and before the peerages, I naively believed that NZ was not a corrupt country.

"Is monetary policy in NZ now impotent?"
Now?!
If it works, why are we here?
(And, 'things would be so much worse otherwise' is a counterfactual argument with no proof)
It's been dead-on-arrival since New Zealand led the World into Inflation Targetting trap in '90's. ( It's been as successful as the Monetary Conditions Index that we also gave a run to, that thankfully was quietly put to rest)

"2% yield return from bank deposits"
I wish....

Yeah got 1.55% from the ASB for 12 months just before they crashed even further this week to 1.25%. You can only reduce rates so far and its a law of diminishing returns in respect to its effectiveness to change peoples mindset. As above if reducing interest rates "Worked" we would not be in this position to start with.

'RBNZ Governor Adrian Orr keeps pumping the cash. Illustration Ross PayneIs monetary policy in NZ now impotent? '

Why only in NZ but in most countries, if not already.

Monetary policy / QE to avoid adverse affect of coronavirus but what about consequence of extreme monetary policy AND consequence of all can delay but but not avoid the inevitable. Economy cycle has to play out so will get worse before getting better.

Exactly right. Pulling gear stick no good if engine not there.
QE is not same as it going into economy as lending.
Loss of tourism and students is about 20% of GDP but this impact will not be most felt til Dec-March period.
Wage subsidies coming off in next month, hence withdrawal of demand and consumer spending and borrowing.
The fan is now meeting the ordure.
Could not be avoided forever.
Reverse leverage not affecting housing market yet and when it does it will not affect buyers paying over $1.5m and that is segment on rocket fuel, not lower down. Rest of economy has been in extend and pretend but people do not want to borrow more. Caution is the zeitgeist and QE is not going to fix that.

Question? Why do we get given/need ever more debt to goose economy or to stop it imploding?
This question being highly subversive (as in might mean doing something different, or something that makes a difference, or works!) is not asked. Debt replaces wages sucked up by increasing inequality.
Increasing inequality means dearth of demand in bottom 50% of income distribution which is filled in with debt. But when people cannot borrow more and interest rates can't go lower, game over. Try another game

The idiocy of the current policy mix is becoming more and more evident.

Individuals know 2 things:
- wtih lower interest rates, we have to save harder to achieve the same future outcomes.
- with higher government deficits, we have to save more in order to protect ourselves from future tax hikes that are required to pay for the current borrowing.

The monetary side is particularly insane. They're slaves to their models which dictate that ongoing house price increases and credit expansion are key to economic prosperity. Therefore they perpetually lower the price of credit and pump up availability to ram more credit down our throats, trying to make up for the constraint on demand incurred by the previous debt excess. When this doesn't work, they have to bring in fresh meat (immigrants) to prop up the ponzi and provide more willing debtors.

Their negligence is almost criminal.

'They're slaves to their models'.
Sums up economists.

I completely agree. It is time to urgently replace the leadership of the RBNZ before it is too late. The long term distortions created by such incompetence and negligence are going to be highly damaging to the whole economy. The RBNZ policies are delusional and suicidal.

Money from QE never enters the economy it just sits in the reserve accounts of the banks, its only effect is on reducing interest rates. Banks don't lend out their reserves except to another bank if it is short of reserves for its exchange settlement account. Banks create new money when they lend.
Only the money that the government creates by its deficit spending can stimulate the economy and the government must first create currency before it can tax or borrow, spending occurs first and taxation and borrowing happens afterwards.
Only the government can create NZ Dollar currency, banks can only create credit money with a debt liability attached.

Treadlightly

Bang on well said.

Also certain columnists here argue well why do banks need mum and dad deposits. To settle their settlement accounts. If they don't then they are in violation of their banking license.

They work together the banks to get the bank books to balance. When it gets difficult then the central bank is lender of last resort. I. E the repo market. Last year the fed pumped 700 billon through repo to help them balance.

I get infuriated when a certain writer says banks lend money from mum and dad depositors.

treadlightly and ponzikiwi, yup.

But what many commentators don't comprehend is that banks aren't *creating" credit money, they are pulling *your* future income forward to give you buying power in the present, and you are losing that buying power in the future (because in the future you have the debt liability to repay). Banks then charge you for this privilege. The money isn't extra money in the system, when you repay the loan, the money is retired.

Wonder where does people like Adrian Orr invest their savings ? How much in Banks here ?

I don't think I could disagree with anything in Roger's article. Central banks seems totally unable to think of anything other than to reduce rates, rinse and repeat, all the time uttering the tired old mantra, 'this time, it will work-possibly'.

What happens when inevitably, negative rates don't lead to a surge in consumer spending and corporate borrowing? How low can they go?

I have made a note of Roger's prediction that the NZ/US exchange rate will go to .70 within 12 months. If heaven forbid, Trump is re-elected then I think that may be wrong(short-term) while if Biden is elected, the markets may well react negatively and push that rate even higher.

The quick downward progression of the RBNZ informed everyone that the NZ economy was in trouble before Covid19. Their impetus post Covid19 to go even lower is a clear sign NZ seems absolutely boned.