By Roger J Kerr
There are two possible scenarios for our interest rate markets over the next 12 months in terms of rate direction and yield curve shape.
1. Global recession 'doomsday' scenario:
- Plunging global growth and commodity prices suggest future deflation risks, not inflation risks.
- Economic carnage in Europe and the US causes a major slowdown in China. The European Central Bank is forced to cut their interest rates. US 10-year Treasury Bonds stay below 2%.
- While the NZ dollar would follow our commodity prices lower (the automatic shock absorber of the floating currency doing its job), incomes in the productive export sector still reduce. Investor, business and consumer confidence within New Zealand falls - despite the AB’s winning the Rugby World Cup.
- The RBNZ keep the OCR at 2.5% for a sustained period, however the yield curve may steepen as foreign investors sell out of periphery bond markets like New Zealand and thus force longer-dated yields higher.
- Borrowing costs do not necessarily reduce and may increase as bank funding margins in disrupted global debt markets increase sharply. Local banks fund their requirements locally with domestic market bond issues.
- Much lower GDP growth than forecast in New Zealand (thus lower tax revenues coming in) forces the Treasury to revise upwards the fiscal/budget deficit forecasts over coming years. Standard & Poor’s more likely than not to downgrade NZ’s credit rating under this scenario and thus another reason for borrowing margins to increase.
2. 'Muddle-grind through' scenario:
- A global double-dip recession is avoided and there are no major bank failures in Europe. Investment and financial markets stabilise and settle in for the long slow grind to economic recovery.
- The Europeans do manage to contain the fallout from a Greek debt default and investor confidence slowly returns.
- The US Congressional Joint Committee mandated to find the fiscal policy and debt answers come up with a credible plan by 23 November. Again, investor confidence restored and the US economy slowly recovers.
- The Obama administration finally recognise the major blockage in the US economy is the residential real estate market and come up with a rescue-bailout package for those underwater with negative equity.
- Commodity prices stabilise and the Chinese keep their domestic economy humming along.
- The NZD/USD falls far enough for export industries to hedge forward to protect profits and they start to invest/expand again. New Zealand GDP growth recovers up to the +3% area in 2012 and the RBNZ have the room to return short-term interest rates to “normal” levels of around 4%.
- Credit spreads in international debt markets slowly come down, eventually lowering bank borrowing margins.
- Long-term bond yields go no lower than current level and eventually move up on the prospect of global growth and moderate inflation increases in the long-run.
What I think
My best guess of the probability weightings of these scenarios eventuating into fact?
Scenario 1 = 25%
Scenario 2 = 75%
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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
24 Comments
Pick option one and ride the storm out as best you can. Rates will rise for the reasons Roger lists.
The warnings started three years ago. This end game period is likely to be stretched into many many years.
Over time expect better RBNZ and NZ govt management toward encouraging greater savings rather than just blathering about it...and an end to the country being farmed by the banks.
It is a move to thrift and prudent behaviour...it will take decades. In the long run, if this is not buggered by political stupidity, we will be lending to the world instead of the world lending to us.
You can face the word "depression" can you Roger. Every time, you fail to take into account the Peak oil impact. I think maybe you are goin to need a lot of Prozac shortly...
http://theautomaticearth.blogspot.com/
"That is, unless a miraculous growth spurt appears out of the blue and against all the odds dictated by reality as we know it today. In other words, more capital injections simply and only mean more double or nothing gambling. We need restructuring, not replenishing. We need to sleep this one off, not get a refill."
http://www.econmatters.com/2011/08/roubini-sees-60-chance-of-double-dip…
"We’ve reached a stall speed in the economy, not just in the U.S., but in the euro zone and the UK. We see probably a 60 percent probability of recession next year, and, unfortunately, we’re running out of policy tools.....and sovereigns cannot bail out their own distressed banks because they are distressed themselves."
and neither of you discuss Peak Oil,
"What I think My best guess of the probability weightings of these scenarios eventuating into fact?"
Scenario depression = 75%
Scenario 1 = 20%
Scenario 2 = 5%
regards
There is always a possibility we will muddle through...this is certianly how most ppl see it....on the other side will be more growth and happy lives etc etc...
75% actually has an even darker side.
24% = The Great Depression
25% = The Long Depressiom (worse than GD)
25% > (ie worse than) the Long Depression...so this one is a 90% collapse in house prices etc etc.......
regards
1% == us in the stone age........
regards
I go with recurring crises as in the 1970s. The problem is the same - overindebtedness in the major economies- and will only be resolved by financial repression and significant inflation over the next decade or so.
Eventually sanity will be restored by positive interest rates as in the early 1980s.
Basically everything is unstable so each crisis triggers some unexpected collapse somewhere which the authorities then rush to contain. Once each breach in the dyke is patched up everything looks fine until the next crisis hits. It's just an unstable system.
In the 1970s there was a sort of inflation ratchet effect; inflation in everyday goods led to wage demands based on inflation which led to more inflation in everyday goods, all aided by government policy of keeping interest rates below the rate of inflation. In this environment it made sense to own gold which became the next bubble. Eventually, once the debt burden was reduced to a manageable size (10years?) then interest rates were raised to a rate higher than inflation. This gave real value to national currencies and gold fell in price.
At the time it all seemed very confusing but in hindsight its just the mechanics of inflating away national debt from an unmanageable level.
Terry Seripisos is a classic example of the other way of resolving unmanageable debt burdens, it is faster but more painful in the short term.
Please explain what you mean by 'financial repression and significant inflation' to resolve indebtedness?
Inflation is of course an increase in the overall money supply and new money entering the money supply can only be created by way of bank credit through someone (a government, corporation or human being, etc) borrowing it into existence. Surely this means significant inflation means more indebtedness?
By 'financial repression' do you mean less lending? or high interest rates? If so, then one would think these would tend to lower inflation (i.e less lending = less new money creation = less money added to overall money supply = less inflation?)
Or are you talking about price inflation or increase in the CPI rather than real inflation?
Hi Stray76
I agree with what you say about the overall money supply however you cannot talk inflation without mention of the supply side.
At the moment the world has a vast over supply, (every country is desperately looking for a market, ie growth). But the West, being by far the biggest consumers of this supply, cannot aford to borrow and buy as they are allready sinking in debt. So there is a supply recession. At the same time we vast money printing causing an erosion (devaluation) of the currencies which is inflationary. At the moment one is offsetting the other.
Well the answer is simple he's wrong, he's a numb skull...at least about inflation....this isnt like the 1970s....this is how things look after peak Il and not after a human made shortage from the 70s.....way different.....
In some ways he's right because financial repression is relative and really comes down is it worth taking on debt and, your ability to service that debt.
I see deflation, and significant house price drops of at least 50%.....now if you have a 80% or even 95% mortgage that means you are under water....by a long way and will never get out.....ever....
Of course it gets worse.....your wages also suffer deflation.......so if you are earning $100k and you have a mortgage of $200k not to bad.....but if your wages are cut to $75k but the debt remains you are in a bad way, if your wages drop to $50k, well you are screwed and royally.
In a credit defalut situation credit is no longer available, or simply to expensive read up on te Great Depression. For instance with inflation buying plant at say 7% interest and 4% inflation means its costing you 3%....and most importanly ppl are buying.....with deflation you are buying plant and even if the interest rate is 4% with 10% deflation you are really paying 14% and more imprtantly no one is buying.....they are all holding onto cash.....what little they have.
"(i.e less lending = less new money creation = less money added to overall money supply = less inflation?)"
Yes, you are correct IMHO.....though worse, not less inflation but actual dis-inflation which will now lead to braod/overall deflation....
"increase in the CPI rather than real inflation?"
From my point of view there are ppl in here that think printing money means inflation....its a very....uh...simple view of the world and wrong, the world isnt that simple....try explaining that to them though..........and yes most of them think CPI is real inflation.......when core is the one to watch and its at best flat.
Commodities are collapsing as the cheap speculative money leaves them....so CPI will also drop back.....which means core will drop.....
Which means deflation....unless we see more can kicking......2 or 3 more years and it explodes....
http://peakoil.com/bussiness/roubini-and-soros-say-the-u-s-already-in-a…
regards
Sorry I'm a bit late replying, but here is the best link I know of on the subject of financial repression:
http://www.imf.org/external/pubs/ft/fandd/2011/06/pdf/reinhart.pdf
Enjoy.
But I wager he would not lose his irrepressible spirit Steven.......and if you are to lose all ...it's the one thing that will provide an outlook to new beginnings...
Keep smiling.......{ : > )
You know Steven, in all honesty I can understand the satisfaction of a man who never took a chance and lost ....and his vaguely stifled glee at not being caught in an unraveling of events.
But I do still wonder who was the richer for the experience.....and perhaps would remain so.
There is a difference between a calculated risk and a gamble......
Im certianly not a gambler......on the other hand selling everything I had in the UK, and coming here to NZ was a considered risk and its very much paid off....
Experience I think is one of the best learning tools.....however if you fail and get burned is it sensible to do it again or do something else? so thinking counts as well to determine which course of action.
Look at what they are saying about the big funds and "wise" investors.....they have bailed.....so Im simply with those guys....
"his vaguely stifled glee" more like relief n my case, but I expect to get caught up anyway, Im a tax payer afterall.....just I aim to survive. You could say Im protected and Im in a position to move when I need to. There will be opportunities as a trader was saying on a youtube piece in here this morning. Those that were ready in the GD and bought at firesale prices did pretty well....So those that are ready will make a profit/living...
Imagine you are a PI and sold your 10 $500k houses with the view that you considered there was going to be a 50% drop....you would buy back at a huge discount and even if renters couldnt afford the present rents, no matter you have a huge margin.....PIs who stayed in the market are where?
The downside is of course this doesnt happen and you lose some %.....currently we are seeing 5% loss.....no sign of gain....and with cash you can buy backin pretty quickly.....so I see a huge asymetrical play....on the one side holding sees small losses or small gains risking huge wipe out losses v pretty safe with small losses with probably huge gains......think its more than 75% sure on the latter.
regards
Gummy is mortgage-free , and owns some parcels of farm land , plus two beachfronts .. in a nice tropical spot ( as per Simon Black's advice , the " Sovereign Man " ) .
..... everyone should have such a " world-goes-to-hell " back-up plan , a plan B if you will .
But in the more likely event that we muddle through , and well managed countries ( many in Asia , Germany , Australia , NZ , Canada , most of Scandinavia ) will probably recover eventually , and prosper ; then the GBH stock portfolio will continue to yield a generous cashflow . .... Yipppeeee , the gummy bears are on me !
... we pass this way but once my friends , live as kings & hero's , not as skulking wee ground burrowing varmits .
GBH - some of us aren't that stupid. We address realities, rather than superimpose wishful-thinking on them.
Kerr just reinforces the growing awareness that 'economists' and 'market commentators' are now out of their depth - and until economics teaching includes absolute limits to growth, they'll continue to be so.
Christov - no. It is far smarter to ascertain whether to gamble, before entering the fray. I first learned of the Hubbert Curve in 1976. I spent some time checking it out, and haven't been burned since.
True, it is better to have loved and lost than never loved at all, but it is not better to have gambled and lost, that's just a portion of your life gone. Better to learn enough to stay clear of the casino
Chuckle - go well Count.
I had this in mind......
" The masses have never thirsted after truth. They turn aside from evidence that is not to their taste, preferring to deify error if error seduce them. Whoever can supply them with illusions is easily their master; whoever attempts to destroy their illusions is always their victim"
"The Crowd" A study of the popular Mind
Guatave le Bon 1896
Australia about to cut/cutting rates:
"Economists expect the RBA will keep rates on hold for the next few months but believe a worsening in the world economy could trigger a cut later this year. However some lenders already cutting their rates." http://www.ratedetective.com.au/interest-rates
Rate cut will be in November in Australia:
http://au.smallbusiness.yahoo.com/finance/cash-flow/a/-/10272828/rate-cut-tipped-for-november/
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