With interest rates down and seemingly heading ever lower, David Hargreaves ponders how long the remarkable restraint being shown by the New Zealand public will last for

With interest rates down and seemingly heading ever lower, David Hargreaves ponders how long the remarkable restraint being shown by the New Zealand public will last for

By David Hargreaves

People might have been disinclined to believe you if you had told them around a dozen years ago that one day a bank (Westpac in this instance) would be nearly killed in the rush for an issue of bonds offering the princely interest rate of 2.22%.

Wow, hold me back, you might have said, sarcastically.

Bear in mind that exactly 11 years ago, in 2008, you could, according to Reserve Bank figures have invested in a six month term deposit yielding in excess of 8%.  

But that's where we are now. Interest rates are disappearing into infinity. The smart money's on the Reserve Bank trimming the Official Cash Rate on Wednesday, August 7, to 1.25% from the current 1.5%. Economists at the big banks see a further cut this year after that, taking the OCR down to 1%. And now, there's increasing chatter that 1% won't be the bottom either.

So, perhaps no wonder that $900 million worth of money thrown at Westpac suggests plenty of people not only think 2.22% is looking fine as a return, but that it might even look rather better six or 12 months down the track.

Such restraint

What hits me though, is the apparent restraint in all this. Returns are declining but people mostly don't seem like they are doing silly things in pursuit of bigger bucks.  A bond issue through a bank is an inherently sensible way to invest. Anybody will tell you there's no sure fire safe investment, but anything involving a very large bank is at the more sure end of the spectrum.

And people do appear as if they are being quite careful. 

For now, even though advertised bank term deposit rates are dwindling, the banks are still taking in reasonable amounts of money, as these Reserve Bank figures suggest. (Just as an aside though, I see from the detail in the spreadsheet attached to that page that the annual growth rate in deposits dropped to 5.4% in June from 6% in May - so, it will be interesting to see if there was a further drop in July.) 

Deposit rates are one thing - but yes, of course, the borrowing rates are plumbing the depths too. That's something people are likely to be more cheerful about. If we go back to those 2008 Reserve Bank figures again we can see that in July of that year the floating mortgage rate for new loans was 10.88% - as of June this year it was 5.73%. 

There's two differing things at play here then. On the one hand as an individual if you are looking for 'safe' investments the returns are hardly enticing. But on the other hand, if you want to go out and buy something, you are able to (providing someone will lend) borrow largish sums of money without then needing to endure the kind of interest payment pain that would have once entailed.

A recipe for spending

It all appears a recipe for an environment in which people don't bother saving and instead ramp up the spending.

At the moment the signs are that this isn't really happening. 

It may well be reasonable to surmise that at least part of this is down to a lot of people having geared themselves up in the recent house market boom. And it may be people remembering financial hardship as the effects of the GFC unravelled the housing boom before that.

So, it may be that people, not trusting of how long this low interest rate environment will continue, are keeping it sensible. Paying down debt. Putting available cash into the bank.

I do wonder though, what will happen as interest rates head even lower and if, as we get into next year, all the signs start indicating that low rates will be with us all of next year and into the following year. 

I've been a little surprised we haven't seen more of a rise of, shall we say, 'alternative' financial ventures offering higher returns. But then again, perhaps much of this is down to the tidying up of our regulations in the wake of the finance company sector meltdown

Maybe starting up such ventures is regarded by most now as in the too-hard basket.

Patience will be tested

Inevitably though, the longer we go through this low interest environment then surely the patience of savers will be tested beyond the point of cracking. 

And likewise, on the flip side, as long as money is available for borrowing at cheap rates then there will be increased temptation for people to borrow and spend. That might not be a bad thing for the individuals concerned and indeed the economy in general  if the money is spent on solid assets. But there would be some concern if there was any chance of a re-ignition of the housing market. 

On the latter point, I can't really see the housing market reigniting. But of course increased competition for any asset class will theoretically push the price of said assets up. So a refuelled housing market would not be out of the question. Indeed maybe there would be some pushing up in price of other consumer goods. I think this is what they call inflation! But difficult to see any of that right now.

Probably the key thing here will be the attitude of the banks and whether they keep a tight rein on lending and, indeed, whether they further 'ration' lending as has been suggested/threatened if the Reserve Bank goes ahead with its proposals for the banks to hold much more capital. (Personally I'm very doubtful the banks would or indeed could carry through on their dire threats and I see such threats as pure posturing.)

I reckon over the next 12-18 months though it will not just be the patience of the public that's tested. I think the patience of the banks will be tested too - particularly if some new types of competitor do find a way into the market, both for taking deposits and lending. Therefore, there may well be the temptation for banks to start relaxing lending criteria again. 

When it comes to houses, the RBNZ of course has been slowly letting the handbrake off when it comes to high loan to value ratio lending - and I would be next to certain that the LVR 'speed limits' will be further loosened when the RBNZ issues its next Financial Stability Report in November.

A further relaxation of the LVRs would certainly offer more temptation to the banks to free things up a little. And while that's not seemingly the inclination at the moment, if they do see themselves losing market share to competitors, well, the instinct is to compete...

I guess what I'm really saying here is that these are potentially risky times ahead for us all. 

The risk of temptation

If easy money is going to be available to borrow that's a temptation. If the 'sensible and safe' term deposit rates continue to offer virtually zero bang for our bucks then so the temptation will be there to 'try things' with our money in order to get returns that satisfy.

Looking back over the history of New Zealanders as money managers, we've had our moments when it comes to personal investment disasters. I've opined before over what I regard as (still) generally disappointing levels of financial numeracy in NZ. 

The sharemarket crash of 1987 is remembered now globally as just a quick blip from which markets soon recovered. Here in New Zealand that was far from the case because of the large numbers of people who had clambered into the sharemarket, made worse by the fact that the NZ companies they were investing in were, by and large making money just by investing in each other. It was high stakes musical chairs. When the crash hit the music stopped. There were no chairs. The money was gone. For everybody.

And then there was the previously mentioned finance company sector meltdown. I dare say there must still be plenty of people out there financially hurt and emotionally scarred by that.

Both the sharemarket crash hangover we had here and the finance company fiasco were a result of an environment in which large numbers of people, all enticed with one type of investment, decided it was THE thing to do. And without being necessarily properly equipped in terms of investing skill, in people went, boots and all.

So, as personal investors we have shown past vulnerability. I would suspect that vulnerability remains.

Low inflation and low interest rates sound wonderful in theory, but there's no doubt the current environment has its challenges.

And with further interest rate falls coming, the challenges will continue on in the foreseeable future. We will all need to keep our wits about us.   

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5% inflation next year. watch out

Even if there were 5% inflation, the reserve bank would never put up interest rates. They wouldn't dare. They would "look through" it, decide to stop measuring it, or change the definition of it. Just like they've done with GDP, wages growth, unemployment, immigration, and any other metric that might let on to the population that they're being screwed over.

Disappearing into infinity?

One can cut interest rates in half to infinity.

Moving away from the viewer, so they get smaller and smaller.

The "Vanishing Point"

Its Barfoots day. There may be a need to redirect comments.

If the Oz banks did ration lending then Kiwibank could take up the slack. Which would be good as long as they were prudent.

Uninterested - where do you seriously think that Kiwibank could raise even a small percentage of the required capital to pick up the lending of just one of the big banks, especially with the RBNZ's new proposed capital requirements coming in from April that will produce such a poor return on capital that the likes of their existing shareholders (Super Fund and ACC etc) could hardly justify what they'd have there now, let alone provide more?

13
up

Everyone already knows that shares are overpriced. Property is overpriced. All assets are already overpriced. The amount of debt that has been taken on to buy these assets already exceeds their real value.
So the only option is to accept low returns for a long time, as the debt is repaid, painfully slowly,
or to write off massive chunks of the debt either directly or through inflation.
Am I missing something?

Also, from the article (sorry, don't know how to quote):

...Both the sharemarket crash hangover we had here and the finance company fiasco were a result of an environment in which large numbers of people, all enticed with one type of investment, decided it was THE thing to do. And without being necessarily properly equipped in terms of investing skill, in people went, boots and all.

Doesn't that sound like Auckland housing? It seems like every generation gets its own flavour of financial meltdown.

It had happened before. Securitibank. JBL. Broadbank.Then later RSL. And then 2008 the utter shambles of the collapse of 90% of the finance companies that had risen out of the ashes of all those. It’s a wonder one of them wasn’t called Phoenix. Gareth Morgan made the comment, and he was absolutely correct, that most investors had though government authorities had implanted sufficient safeguards. Well they hadn’t had they and who could say that this echelon of investment is any safer today. The best return is the return of capital. Term Deposits then?

I agree that all assets are currently overpriced, except for gold, which has languished for years and is now starting a run (see my comment below). Almost everyone has forgotten about it and written it off, until late last year when it became more clear there’s trouble on the horizon.

The unspoken elephant in the room is global govt debt, which is give-or-take $100 trillion. With increasing expenditure on welfare (ageing and obese populations, etc), and growth tanking, a greater proportion of govt revenues is going towards debt servicing. Any interest rate increases would destroy govt budgets, and hence the political pressure to lower rates. When people realise that govts are incompetent and driving us towards ruin, then confidence in govt and our monetary system will collapse. We are at the point of no return I believe, and the consequences will be of major historical note to say the least.

Wonder who were the buyers/investors of Westpac's bonds ? Overseas funds/banks ?

Those that don't expect the reason they might be a good short term buy (interest rates falling further) could also be the cause of them not getting their capital back.

Excellent point. After the BNZ news about not operating responsibily I wonder if the other banks are doing the same.

A good amount will be destined for the low risk Kiwisaver funds

What does the RBNZ hope to achieve by continually lowering interest rates? If they think that will encourage/force those who have some money to spend it, a sort of indirect way of reducing debt, then they will need to think again. People, especially the elderly, just save more because they are trying to maintain their assets and lifestyle. People just hunker down in a recession. They spend less..... But if the Banks pass on the cut then the giant Ponzi house fiasco will go on and on until it crashes. But will the Banks do that because they want to make more profits in case they actually have to have more reserves? Now if you want people to spend then give them more money. Increase benefits, increase minimum wages. Increasing dependence on credit is not a good idea. It is not rocket science.

And cut taxes..Starting with giving full tax exemption for the first $10/15k earned as interest from bank deposits.

Out of a Labour government? Ha! Keep your chewing gum in your pocket, or on the bedpost overnight.

Yes Patricia all of that and as well any stimulus provided by the long period of OCR cuts has done its dash, well and truly. So in place of that is the stark encouragement to borrow more. Upgrade the house, take the big overseas vacation, expand the paint shop, import more cars for the yard. Yes indeedy in land of poor saving history, this is just what NZ needs, not!

For many households, by far the largest modifier to their financial behavior is the recent increases in accommodation costs.

If you are renting, or if you have taken on a mega mortgage since prices ramped up post 2009, all you see is your money flowing into a black hole, forever. A 1% ocr cut wont change anything in any way for these people. Paying back a 600k mortgage is still 600k of after tax paychecks to earn.

If it was only financial assets that had blown up in this bubble that would be one thing, but when it is shelter (a necessity) there is no way to avoid it. It slants the spending behaviour of a huge chunk of the population. People with 30 year mega mortgages will be living and spending like uni students until they retire, no matter what the ocr is set at.

Gold and gold ETFs have quietly risen nearly 13% (in NZD) over 6 months, and 20% over the past year, after languishing for years. I see that continuing, likely to all time highs and beyond, as housing market and sharemarket eventually decline. It’s been a strong 10 year run (340% for the NZ50 index and the NZ and Australia real estate bubbles), but as Ray Dalio said recently, another “paradigm shift” is on the way. It’s unlikely to be similar over the next decade.

Yes. You wouldn't read about it in the Herald though so most people are oblivious. I've owned GOLD on the ASX since 2006. Only really come to life in P6M. I think we're still a way off the point when people realize that paper gold is also something of a scam. Will need to time the exit accordingly.

JC, it could turn into a bit of a gold bubble in time, which would be quite apt for the Trump era really. If it does, there'll be the usual pile-on by "most people" not long before it bursts. In the meantime, I think gold has a long way to run over the next few years, and there'll be a lot more investors buying as this economic cycle comes closer to ending. In the meantime, the all time (NZD) high of $2307 /oz reached in 2011 is not that far off already. I wouldn't be surprised if it goes waaaay higher in a bull market for gold in the early 2020s. In any case, it looks good, and has been pretty good this year already.

Question, does anyone have info on how cash / deposits in banks are held across different age groups?

Surely this plays a part in how likely people are to spend / not spend that money, and on what.

I have never really had to think about it much, I mean money in the bank has always earned reasonable returns for limited risk.... that was then this is now... Now I feel a bit like a deer in the headlights financially, nowhere to run and nowhere to hide.

Does anyone know if you have term deposits in the same bank as you have mortgages are those deposits somewhat safer?

If your deposit was small relative to the mortgage debt then I guess the bank needs you to remain viable more than you need it, so you'd arguably be better set that way. All creditors of the same ranking would be treated equally in terms of capital return, irrespective of whether they were also debtors.

Zachary Smith asked an important question: "Does anyone know if you have term deposits in the same bank as you have mortgages are those deposits somewhat safer?"

I've often wondered about this situation--what would happen if a bail-in event happened, for example, to a bank customer with 90k in deposits and 600k debt (putting aside the question of why this bank customer hadn't used the 90k to pay down more debt, e.g., waiting for their fixed term debt to renew to repay more debt, or using it to fund ongoing business operations). This is an important question: could the 90k deposits (minus any bail-in threshold) get bailed in while the 600k debt obligation is not reduced by the amount of the haircut on deposits?

The way I read the open bank resolution white papers, this issue is not explicitly dealt with. I used to think there was "protection" by having more debt than deposits at the Ozzie banks in NZ. Now I'm starting to believe they could execute a bail in and then whichever receivership or new owner takes over the failed bank's assets would treat the 600k debt note as an asset without marking it down by any bail-in amount. Would someone with knowledge about this tell us what to think about this scenario? Is having more debt than deposits not providing any protection of the deposits in a bail-in event?

‘Both the sharemarket crash hangover we had here and the finance company fiasco were a result of an environment in which large numbers of people, all enticed with one type of investment, decided it was THE thing to do.’

I wonder what investment type everyone has decided is ‘the thing to do’ this cycle.

Well the bitcoin conmen are out in force. I expect this will vaccine up some cash from the naive.

Buttcoin in particular . .. but Craptocurrencies generally.... you can't lose with Buttcoin maaaaate ... they're not making any more of it ! ...

I know the theory but I cannot see any valid reason for the RBNZ to lower interest rates. Actually can't see any necessity for the lowering they have done already

Many would wonder .... fortunately the RBNZ and IMF are arranging a conference to sort it out https://www.rbnz.govt.nz/research-and-publications/seminars-and-workshop...