Markets are trading more cautiously, with Europe’s likely delayed recovery not helping. Global equity markets are flat, US Treasury yields have nudged down further and oil prices have plunged around 6%. The USD and JPY have been the strongest. The NZD has been in freefall since the government announced measures to curb runaway house price inflation, tacking on another 1% of loss overnight to yesterday’s significant fall.
The NZD has been whacked and NZ rates headed lower after the government announced a range of supply and demand side policy measures designed to attack excess house price inflation and tilt the playing field away from investors and to first home buyers.
On the demand side, these include an extension of the effective capital gains tax for investors (to capture investment properties held for less than 10 rather than the 5 years currently legislated) and, more significantly, the removal of interest rate deductibility on investment properties, immediately for future purchases but phased in over the next four years for existing owners. Supply side measures include a $3.8b contestable fund for councils to fund infrastructure around new developments and easing the path for the state housing agency to acquire land.
We see the policy mix as making the RBNZ’s job of driving inflation up more difficult. With lots of moving parts it’s hard to get specific with numbers, but the direction of influence from here seems clear – lower house prices, higher rents, less future monetary policy tightening required and less growth in housing debt going forward.
The RBNZ has been, in part, relying on higher house price inflation to drive wealth effects in the economy that lead to higher domestic inflationary pressure. After a period of incredible house price inflation, there’s a reasonable chance that not only house price inflation falls from here, but the level of prices falls as well. (In the February MPS the RBNZ assumed a 14.1% lift in house prices between March 2021 and March 2024 or a compound annual growth rate of 4.5%). Whether or not higher rents provide an offsetting impulse to CPI inflation from the wider negative macro forces of these policies is doubtful.
The policy measures significantly increase the uncertainty about the outlook. Will the measures cause a quick-fire 10-15% fall in house prices or will they simply hold back further appreciation? What will the flow-on impact be for the rest of the economy, given its already current fragile state? Does this undo all the significant work the RBNZ has so far done to drive inflation higher?
The market reaction was consistent with the view that measures will be negative for the economic outlook and the pricing of rate hikes through next year was reduced – now just one hike priced in for the whole of next year – driving a chunky 8bps fall in the 2-year swap rate to 0.42%. An even larger fall was evident in the 5-year rate – down 11bps to 1.05% – suggesting that the market sees the economy being more sensitive to interest rates and less upside risk for the OCR from a medium-term perspective. The 10-year swap rate fell 6bps to 1.87%. Similar moves were seen across NZGBs, with the belly of the curve underperforming.
The NZD has steadily declined since the announcement and is probing fresh lows as we go to print. Previous strong support at 0.71 proved no match for the hand of the government and the currency is now approaching the next level of support at 0.70, down some 2.3% since this time yesterday and at a level not seen since just before Christmas. A stronger USD backdrop has accentuated the move, with the BBDXY index up 0.5%. Notably, the AUD is down 1.2% since this time yesterday to 0.7660. NZD/AUD is down to 0.9160, breaking previous support above 0.92 and now with the August low of 0.9055 in sight.
With JPY holding up in the risk-off backdrop, NZD/JPY is also down well over 2% to 76.2. Other NZD crosses are also well down, albeit not as much. Given the increased uncertainty about the domestic economy and rates outlook, the knee-jerk market reaction appears fair and, like others, we will need to reassess our currency outlook alongside any possible changes to our macroeconomic outlook. However, we are mindful that global forces are the predominant driver of the NZD and domestic-led movements are often only transitory.
In overnight news, Fed Chair Powell and Treasury Secretary Yellen began a two-day hearing in front of lawmakers and are still being grilled as we go to press. Powell reiterated the message from last week’s FOMC statement, indicating that the Fed would provide support to the economy for as long as it takes and played down the risk of inflation getting out of hand, seeing an expected lift in inflation as temporary in nature. Yellen repeated a previous comment she has made suggesting that the US could return to full employment in 2022. So far, there has been no comments of a market-moving nature.
The S&P500 has been trading in and out of positive territory and is currently flat, although small caps haven’t fared too well, with the Russell 2000 index falling more than 2%. Despite negative headlines on extended European lockdowns, the Euro Stoxx 600 index fell by only 0.2%.
Oil prices are down by over 6% on concerns about the demand outlook over coming months in light of the likely delayed recovery in Europe due to extended lockdowns. Yesterday we noted that German leaders imposed another four-week lockdown, while in addition to that a five day lockdown over Easter will be particularly harsh. Brent crude is trading below USD61 a barrel.
The US 10-year rate has tracked a little lower. It fell to as low as 1.624% overnight and currently sits near 1.64, down 2bps from the NZ close.
In the day ahead, the economic calendar is full, with US and European PMI indicators for March being the highlight. The key questions are how are the lockdowns in Europe impacting economic activity and how much better is the US economy performing? Powell and Yellen face another day of questioning in front of lawmakers, this time the Senate Banking Panel.