Reserve Bank Governor Adrian Orr speaks about monetary policy to the Peterson Institute, in Washington DC this week. Photo / NZME
OPINION
Welcome to Inside Economics. Every week, I take a deeper dive into some of the more left-field economic news you may have missed. To sign up to my weekly newsletter, click here. If you have a burning question about the quirks or intricacies of economics send it to liam.dann@nzherald.co.nz or leave a message in the comments section.
Q: I see markets have fully priced in a 50 basis point OCR cut in for November and are already pushing 50% odds of a 75-basis-point cut. Why are they always so keen to see interest rates come down?
- L. Forrest
A: If you haven’t checked lately you might be pleasantly surprised by the state of your KiwiSaver balance. That’s one of the upsides of falling interest rates. Sharemarket investors get excited by lower rates because they shift the weight of investor money from cash investments like bank accounts towards equities.
US sharemarkets have been on a roll lately, buoyed by the first US Federal Reserve’s 50-basis-point interest cut in September and expectations of more to come.
Even the local NZX50 has seen some good growth after about two years in the doldrums. As Mark Lister – head of private wealth at Craigs Investment Partners – wrote for the Herald this week, the local NZX 50 index has rebounded strongly since June and is up 9% so far in 2024.
“That’s close to the long-term average, and it’s much better than we’ve seen in recent years. The market eked out a gain of just 2.6% last year, after declines in 2021 and 2022,” Lister said.
The most basic reason for the renewed strength is that if bank deposits are heading lower then people who want a better return have to try their luck elsewhere.
Sharemarkets might be a bit riskier but the risk-reward equation starts to look better by default if the returns for safer investments decline.
Lower interest rates are also good news for businesses looking to borrow and grow. So there’s a boost that comes from listed companies paying less for debt and generally having more funds to use for other things. Finally, lower interest rates also give consumer confidence a boost. If consumers spend more then that should also flow through to business profits.
So lower rates usually translate to higher sharemarkets. Great news for share investors but also many more of us via our KiwiSaver accounts.
Not surprisingly the companies that benefit the most from lower rates are traditional businesses that sell things.
In the past couple of years – while rates have been high – we’ve seen a tech sector boom keep things elevated.
The big tech stocks aren’t so directly connected to economic conditions because their investors tend to be less concerned about short-term profits and more interested in long-term growth.
We are now seeing a lot of investment money shift from high-tech stocks to more traditional retailers, power companies and utilities. That’s good news for the NZX.
It also creates a bit of risk. Thankfully we haven’t seen a tech crash – the way it did back in 2000 – but as the interest rate and economic landscape change we’re seeing a big rebalancing on markets,
When we talk about the “market expectations” for what the next OCR (Official Cash Rate) call will be, what we are referring to is the price that financial investors are prepared to lock in rates at a certain date (based on speculation about where they think the OCR will be sitting).
The Overnight Indexed Swaps market effectively provides a live proxy for the OCR. But because it is speculative and based on assumptions about the state of the economy in the future, it is extremely volatile. The odds move around every day and can turn on the smallest piece of news or shift in market sentiment.
The bets traders place should be based on carefully thought-through analysis of where the economy is headed. The banks and financial institutions that make these trades have economists producing forecasts to inform their decisions.
So market expectations shouldn’t be driven by wishful thinking. But it does sometimes seem to be the case that market enthusiasm for lower interest rates drives momentum in the swaps market.
In the US, it feels like the Federal Reserve and traders are playing a giant game of poker. Investors anxious for insight into Fed thinking will overreact to the slightest shift in the language used by any of the Federal Reserve Governors (there are seven, representing different regions of the US) in speeches and media conferences.
Sometimes a few words are enough to trigger a Wall Street sell-off. So the Fed has to push back and sometimes the governors (or chairman Jerome Powell) will attempt to manage expectations with a specific speech or statement.
As you mentioned, traders in New Zealand right now have a 50-basis-point (bps) rate cut priced in for the Reserve Bank’s (RBNZ) next Monetary Policy Statement (on November 29)
And they are putting odds of around 50% on a 75bps cut. Most major bank economists think that the market is getting a bit ahead of itself and are sticking with forecasts of 50bps. They do see 75bps as a possibility, especially if labour market data due next week comes in weaker than expected.
As I noted last week the bar for a 75bps cut is quite high – in the past cuts this size or bigger have been reserved for big shocks like the Global Financial in 2008 or the Covid-19 pandemic.
The RBNZ only cut by 50bps after the Christchurch earthquake in February 2011.
There’s more enthusiasm for a big cut from other commentators – like Devon Funds head of retail Greg Smith who (in this Herald opinion piece) acknowledges the argument that large reductions are generally reserved for “extreme” circumstances. But he says: “It can be argued we are in such circumstances now.”
I’m not convinced things are that bad right now, but regardless, with inflation under control, I can see a good case for getting the rate back to neutral as quickly as possible from here.
So, I’d be happy to see a 75bps cut – not least because I’ve delayed refixing my mortgage until the end of November.
Speaking of clues from central bank speeches, we’ll get a pretty comprehensive overview of the RBNZ’s world view when governor Adrian Orr speaks about monetary policy to the Peterson Institute, in Washington DC this week.
His speech, Monetary policy during periods of economic volatility, will be published by the RBNZ as soon as he begins speaking – around 6am on Thursday (NZT). For those who are really keen, the livestream will be available on the Peterson Institute’s YouTube channel.
According to the RBNZ website, later in the day, the governor will do a pre-recorded interview with CNBC, with content expected to be published after about 11am NZT. The link to that will be posted on the RBNZ site as soon as it airs.
It seems unlikely Orr’s speech will move markets. I’m sure he will be trying to avoid that. But it will be fascinating to hear him cover the thinking and strategy that has underpinned RBNZ’s thinking through the volatility of the pandemic and its aftermath.
Orr is in Washington to attend the 2024 annual meetings of the International Monetary Fund and the World Bank Group.
He will meet several IMF officials and other central bankers, the RBNZ says.
While we wait for new unemployment and wage numbers on November 6 we can gather a few clues from data released by major employment website SEEK on Monday.
BNZ head of research Stephen Toplis notes that: “Job ads declined a further 0.5% m/m in September as the labour market continues to deteriorate.”
They were down 29.1% on a year earlier and weakness remained broad-based across the economy, he said.
“Their general trend has been in decline since July 2022, and, while falling interest rates will be supportive, we expect the labour market to lag the broader economic recovery.”
Wellington appears to have been hit particularly hard by the new Government’s cost-cutting.
Job ads fell in 11 of the 15 regions in September.
In Wellington (excluding Covid) job ads in the capital are now at their lowest level since 2009, Toplis said.
“It has seen the equal largest annual drop [-40.2%], consistent with relatively weaker business confidence and housing activity. Applications per job ad in Wellington are up 82.9% on a year earlier and sit well above the rest of New Zealand.”
On average across the whole country applications per job ad dropped 2% following a record high and a year of increases.
The Consulting & Strategy (-43.6%), Administration & Office Support (-43.5%), and Call Centre & Customer Service (-42.5%) categories recorded the largest pullbacks in job ads.
“These sectors are labour intensive as businesses seek out ways to cut back on costs,” Toplis said.
Last week I also touched on growing fears that the global economy will overcorrect – swinging from high inflation back to the bad old days of deflationary risk.
UK inflation fell more than expected to a three-year low of 1.7% in September, prompting the pound to fall and traders to increase bets on further rate cuts from the Bank of England this year.
While that under-shoots the central bank target of 2%, economists in the UK have noted that (as is the case here) core inflation and non-tradeable inflation like service sector costs remained elevated.
Core inflation was 3.2%, lower than economists’ expectations of 3.4%, while the rate of services inflation fell from 5.6% to 4.9%, driven by lower airfares.
So perhaps it is too soon to be worrying about deflation risk. But it is clearly falling fast now.
Locally non-tradeable inflation is expected to fall again in the fourth (current) quarter. Council rates, which landed in the third quarter (and were up 12.2% in the year to September 30) won’t repeat this quarter.
Rental prices (up 4.5%) were a big driver but we can see the rate of increase is falling. New tenancies (described in the data as the flow measure) actually showed declines in the past few months. And of course that weakening labour market should continue to depress wage increases and service costs.
Both here and around the world we’ve seen tradeable inflation, particularly petrol prices, fall sharply and give the inflation fight a helpful push.
Thankfully despite the ongoing turmoil in the Middle East oil prices have been relatively stable – trading below US$80 a barrel – for the past few weeks.
The word “relative” is doing a bit of heavy lifting there. We are still seeing price swings of 2% or 3% every day.
Traders are weighing depressed global economic demand against supply chain risk and the equation changes dramatically with every bit of news.
On Tuesday we saw prices spike about 2% after another round of monetary policy stimulus in China and lifted hopes of economic recovery (and increased demand) there.
But, with Brent Crude Oil still trading at about US$75 (as of Tuesday afternoon) it looks likely that we won’t see tradeable (imported) inflation bounce back this quarter to rain the inflation-busting victory parade.
Even better, of course, would be a ceasefire in Gaza and a de-escalation of Israeli tension with Iran. We can but hope.
Liam Dann is business editor-at-large for the New Zealand Herald. He is a senior writer and columnist, and also presents and produces videos and podcasts. He joined the Herald in 2003. To sign up to my weekly newsletter, click on your user profile at nzherald.co.nz and select “My newsletters”. For a step-by-step guide, click here. If you have a burning question about the quirks or intricacies of economics send it to liam.dann@nzherald.co.nz or leave a message in the comments section.
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