By Roger J Kerr
Given the RBNZ current stance towards the NZ economic outlook and thus monetary policy settings, the next few months are going to be very uneventful in the interest rate markets. Sideways movement across the bottom is the best way to describe the market environment until January/February.
After that the picture will change, as the markets start to build-in the more likely positive outlook on the economy for 2011 and thus pricing in when the RBNZ will be forced to change their tune and return monetary conditions to “neutral” i.e. a 4.5% to 5.00% OCR.
Last week the market took weaker building permits and business confidence data as confirmation and endorsement of the more dovish RBNZ monetary stance.
In my view that data did not suggest the economy was weakening further, the building numbers were no worse than what they have been and the “own activity” index in the business confidence survey increased.
The “own activity” index is highly correlated to actual GDP growth and still points to +3.5% growth in 2011 – which has been our forecast for some time and remains our forecast.
The RBNZ will, in my opinion, be forced in due course to lift their +2.6% forecast back to this level.
The NZIER Quarterly Survey of Business Opinion out this week will be weaker; however that survey excludes agriculture for some inexcusable reason, thus missing the biggest and strongest part of the economy. The ANZ Export Commodity Price Index and the Fonterra milkpowder auction also out this week will be more important (and positive) lead indicators for the economy.
In delaying the removal of the 2009 emergency monetary stimulus, the RBNZ are potentially increasing exchange rate and interest rate volatility when the export-led improvement in the economy eventually forces them to play catch-up in early 2011 - that is, interest rates will be required to be raised further and faster than what would have been the case if Mr Bollard had stuck to his original (pre September MPS ) plan of a mechanical, stepped and orderly increases in the OCR up to true market interest rates.
I still contend that maintaining the OCR (3.00%) so far below the true cost of money (the 5.00% level the banks are paying for deposits) the RBNZ are going to make it harder for themselves later on.
When they do need to raise official interest rates to have an impact on the economy through bank deposit/lending interest rates, they may find that OCR changes are completely impotent.
When the RBNZ increase the OCR from 3.00% to 5.00%, it is hard to see the banks increasing their deposit rates from 5.00% to 7.00%. They are only likely to increase them to 5.50% to maintain their funding base. Thus I would only see variable home mortgage rates increasing by less than 1.00% over the next 9-12 months from current 6.25% to just over 7.00%, even though the OCR has been increased by 2.00%.
The whole monetary policy signalling and cause-and-effect transmission system is distorted in my view and this is not something Governor Bollard should be too comfortable about.
The Canadian and Australian central banks are currently adopting a quite different monetary policy approach, and I do not see our economy too different to these economies going forward.
Corporate credit-spread pricing also distorted
BBB+ credit rated energy network company, Vector Limited has successfully tapped the US Private Placement (“USPP”) debt market with a 12-year deal at the equivalent of 215 basis points over swap.
Transpower (rated AA) are also transacting in this market at pricing yet to be confirmed, however likely to be in the +175 to +195 range for 12 and 15 year terms.
It is interesting to contrast Vector’s pricing against the 190 basis points Manukau City paid for only a seven year term a few weeks ago. Manukau City was technically unrated, but the debt becomes Auckland Council debt in November which will be rated AA-.
The US pension funds who are investing in the USPP market are now prepared to accept credit margins for a BBB that are almost the same as what local Mum and Dad retail investors want for a AA- rated council.
There is something horribly amiss here, and what it means is that large corporate borrowers are going to go offshore for their debt funding, leaving local retail investors and bank lenders with very few debt issues available locally to put their money into.
The offshore deals will force local credit spreads lower as investors chase what does come to the market. Banks will be forced to drop their current +250 basis points pricing (credit spreads/margins) for corporate debt and as a consequence the banks will be not too keen to pay over the odds for their retail deposits.
Herein lies the major reason why banks will not increase their cost of funds (retail deposit rates) when the RBNZ are forced to lift the OCR from 3.0% to 5.00%.
Price discovery in any market is all about the level of competition. For the first time in three years our local debt and interest rate markets now have some stiff competition.
The previous RBNZ justification for a super low OCR was that borrower’s credit–spreads were substantially larger during the GFC, thus base interest rates had to be lower. The credit spreads are now closing up as the USPP deals confirm. I only hope the economist gurus at the RBNZ have some understanding of what is going on here.
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* Roger J Kerr runs Asia Pacific Risk Management. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com
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4 Comments
Roger , what you describe is distinctly possible , there is every reason to suspect the RBNZ could even now could have already dug itself into a big hole by keeping rates too low .
The domestic market could be constrained by two things that will make accessing cheap funds near impossible for most Kiwi businesses . The first is that Lenders are already looking for 'currency- risk premiums ' in countries like Brazil and South Africa , and so foreign funding ends up almost as expensive as domestic funding. NZ does not have this problem ... yet .
The second is that when economies do turn , and they will , money will become more expensive everywhere , either due to inflation entering the equation in the US or due to higher demand for capital . Then the RBNZ will be scrambling to get out of its big hole and rates could rocket .
The world sems to have forgotten that Capital is in reality is a scarce commodity, and you cant just crank up the printing press . Printing money is like watering down the soup , eventually by just adding more water it end up more water than food and has as much nutritional value as sink water... pretty worthless .
Your analysis b etween the cause and effect re. deposit rates worries me. We are dealing with a false economy here as AB and the RBNZ lift local deposit funding ratios to intially 65% (and soon to be 75%?). This has created a vaccuum and a premium is created on retail deposits as it is set to increase should the 75% ratio be enforced.
The only thing increasing here in time is the cost of borrowing until we have delerveraged sufficiently and we become a growing saving nation.
What a poorly researched piece of work Roger You refer to offshore investors accepting margins on BBB credits similar to local AA- but where do you show what they are, as you only refer to Vector which is BBB+ but probably closer to A- and whose total cost of borrowing was not the figure you suggested.
In the next breath you talk about Transpower at 175-195 - looks like a similar credit margin to the Manukau deal even though a better credit rating.
Have you not realised the world has moved on and the RBNZ now has another tool in the form of liquidity or core funding ratios, when it comes to managing the financial conditions in NZ not just the OCR.
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