Roger J Kerr on today's GDP surprise, the Fed's potential QE tapering, the OCR outlook, NZ$ outlook and why borrowers should fix their mortgages

Reserve Bank Governor Graeme Wheeler might increase the Official Cash Rate (OCR) within the next few months if the New Zealand dollar drops below US75 cents, according to Roger J Kerr.

Kerr, a partner at PwC specialising in treasury advice, told in a Double Shot interview the most likely scenario, however, was for OCR increases to start sometime between March and May next year.

"The risk is, and this is the risk he (Wheeler) is prepared to take at the moment, housing market and inflation turn out to be higher than what they think. And when he does start to raise the OCR next year he has to raise it quicker and in bigger jumps than what many might expect," says Kerr.

Wheeler is currently "playing the game" of buying time, looking at using his new macro-prudential tools to constrain the growth of banks' housing loans.

"He knows if he raises rates now, or in the next couple of months, it's just going to push the Kiwi dollar back up because no one else in the world is raising rates so we'll stand out. The Kiwi dollar goes up and our export growth, competitiveness and profits and investments and jobs and everything else doesn't happen," Kerr says.

"As always they (the Reserve Bank) walk the tightrope, but I think he (Wheeler) is doing the right thing at the moment."

That said, Kerr suggests if the NZ dollar - at around US78.8c this afternoon - fell to US73c or US74c, that would give Wheeler room to raise the OCR from its record low of 2.5%, if housing market data remains strong.

"(If) all the data was still strong in three or four months time, yeah I could see that scenario," says Kerr.

'Fix your mortgage'

Meanwhile, he suggests any borrower who hadn't fixed their mortgage ought to.

"If you're not fixed already you should be."

That's because both risks - the OCR at the short-end of the rate curve, and  10-year US Treasury bonds at the long end, are going up, Kerr adds, with OCR hikes next year potentially being in 50 basis point jumps.

But for Wheeler, with the percentage of fixed-term home loans by value already back above 50% and rising, there's potential for OCR increases from next year to not have much short-term impact.

"The risk is like Alan Bollard found out in 2006-07, you could be raising the OCR really aggressively and it has no impact because everyone has fixed their mortgage and that might be the same situation again. So he (Wheeler) might be raising interest rates and not having too much impact on the housing market," says Kerr.

Bernanke taking foot off the accelerator

Meanwhile, with Federal Reserve Chairman Ben Bernanke suggesting the Fed might start tapering off its quantitative easing (QE) from later this year, Kerr says the US dollar is now firmly on the rise.

"In terms of the US economy, and their (the Fed's) reading of the US economy, what they're saying is the risks are less of it falling back down and he (Bernanke) has set out a whole range of conditions of when they might take their foot off the accelerator."

"I think what Bernanke made very clear, and the market has got to understand this, is they're not tightening policy now. Tightening monetary policy is putting your foot on the brake. All he's doing is taking his foot off the accelerator, as he said in the press conference, a little bit."

For the foot to come off the accelerator a bit US economic data needs to remain positive, with Kerr believing it will.

"At a household level in the US things are going really well now, - jobs, retail, housing," Kerr says.

"The US bond markets and the foreign exchange markets are always pricing the future in a long way in advance so what they're pricing today is what's going to happen in 2014 and 2015, particularly in foreign exchange markets."

The Fed's QE programme currently has it buying US$40 billion worth of mortgage-backed securities per month, and US$45 billion worth of longer-term Treasury securities a month.  The Fed's benchmark interest rates, the federal funds rate, remains between 0% and 0.25% where it has been since December 2008. The Fed's current QE programme is its third one over the past few years, with these having seen the Fed's balance sheet rise to a record high of US$3.41 trillion.

See today's Fed statement here, its fresh economic projections here and Bloomberg's story on Bernanke's press conference here.

US dollar on a strengthening path

"Our view on the NZ-US$ (cross) rate, because of generally a stronger US dollar in global foreign exchange markets, is we're going to spend some time in the US70c (range between US70c and US79c) now," says Kerr.

"The question is do we get to the low US70s or not? I'm not so sure about that but certainly in the high US70c (range) because of a stronger US dollar and what has happened in Australia. The Aussie (dollar) was way over valued and it needed a major correction and it's now having that."

"Eighty percent of the time the Kiwi-US rate follows the Aussie so the most important thing when you're talking about NZ-US rates is probably what's going on in Australia. Secondly is what's happening to the US dollar globally, and certainly our view is the US dollar is now on a strengthening path against all currencies having weakened from 2003 to 2011," Kerr adds.

"It's a big sea change in global currency markets. The US dollar generally is strengthening. That should hold the Kiwi-US rate below US80c but the other cross rates up. And the other cross rates up because the New Zealand dollar's probably going to outperform other currencies against the US. Why would we outperform? Because eventually our interest rates are going up and our economy's doing pretty well despite today's GDP figure."

GDP surprise

Kerr acknowledged surprise at today's Gross Domestic Product data, which showed growth of just 0.3% in the first quarter.

"We thought agricultural production would've been up with the drought and the live stock going to the works early. They (Statistics NZ) clearly count the numbers a bit different to what we thought. We thought there could've been a number above 1% actually, on top of the 1.5% we had in the December quarter, largely based on the ANZ regional growth survey," Kerr says.

Nonetheless, he still has an upbeat outlook for GDP.

"Three percent per annum is what the New Zealand economy did last year and we think that's what it'll do this year and next year," says Kerr.

"All the domestic economic numbers have been strong in recent months (and) the dollar coming back is good for the export sector. If it stays in the US70c range they (exporters) are competitive and can make money, make profits at those levels. It's hard to find any negatives, even the Government's finances are coming back into order so it's all pretty good."

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Thanks for that Stephen.

"The risk is, and this is the risk he (Wheeler) is prepared to take at the moment, housing market and inflation turn out to be higher than what they think. And when he does start to raise the OCR next year he has to raise it quicker and in bigger jumps than what many might expect," says Kerr.
Our very own version of the WSJ's Jon Hilsenrath?

"At a household level in the US things are going really well now, - jobs, retail, housing," Kerr says.
Is this an accident waiting to happpen?  Is the recently reported dwelling sale/price activity in Auckland a function of re-financings seeking to fix lower rates in front of the brewing higher yield storm?

Looking at the result of the Feds comments yesterday will not help the Fed ease next year. , The major economic metrics such has housing, employment etc are a result of ZIRP and QE, remove those and the metrics will be negative and the Fed will have  to put the foot on the gas again. There is a trap set here on two fronts. For average Joe who fixes his mortagage now, he will find 2014 produces a worse  economic outlook and ZIRP will have to be maintained, second Fed will be uncovered as having misread the economy AGAIN, and that nothing has changed since pre 2008, in that too much debt is waying down the economy and even normal interest rates will be too high. Once that cat is out of the bag the Feds credibility will be serverly questioned.
QE has blown bubbles all over the place, Equities, bonds, junk bonds (again), housing in the US is now being driven by investors not home owners as the US home ownership rate is falling, permanant jobs are being replaced by temporary jobs.
If you care to watch the ( you will discover how little the Macro economists know about micro economics. Thats how they misread the data. QE has papered over the debt hole, bad debts still hamper the economy and will continue to do so until they are addressed or inflated away, this will be the most likely way out via repression of earning on saving and inflation being allowed to run higher than interest rates. This will only work if a full blown crises does not happen first.
There is many forecasters who see this scenario, most are those who saw the 2008 debacle and you won't read their views in the Herald. One who did see 2008 coming was Kyle Bass, who is now making a very solid case for a major collapse in Japan within 18 mths to 2 years. Well worth the time listerning to him

"when liquidity dries up"
and if that's not enuff!
"The term "Perfect Storm" is banned by the Telegraph as a lamentable cliché, so let us just say that this is the moment we long been fearing or waiting for – depending on taste – when markets are no longer given what they want"."

Wheeler can do nothing...and will do nothing.
NZ is just a dot in the world of finance and is a hostage of Fed's QE or not QE...
Our interest rate will rise when QE slows or stop and interest rates will drop when QE continues....Nothing to do with RBNZ...whether they like it or not ...