Markets Outlook. What Path the NZ Economy? 7 November research.bnz.co.nz Page 1

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1 Markets Outlook 7 November 2011 What Path the NZ Economy? RBNZ s FSR to probe NZ exposure to Europe s mess As domestic bank margins recover from lows Crown Accts to Sept: improving, despite Super Fund hit? October s transactions expected up 2.5%, on RWC October s PMI a test, given September s near stalling Polls suggest National re-election on 26 November as % of interestbearing assets Banks' Net Interest Margins Some interesting monthly economic indicators are due this week. But so too some generalised information about the economy, in the form of Thursday s RBNZ Financial Stability Report (FSR) and Treasury s September-quarter Crown Accounts. Through the week there will also be more political debates and poll results to keep tabs on, in advance of the 26 November General Election. All of this news will help us judge what sort of path the economy is on. The FSR seems bound to reiterate New Zealand s resilience in the face of great adversity. This time around the disturbance de jour principally relates to Europe. And so we would expect the Reserve Bank to highlight that region s potential implications for the NZ economy, and especially the local financial system. After all, New Zealand maintains important lines of credit with the traditional European markets. The FSR will also, in its running commentary, give insight into the Bank s detailed thinking. We believe this will betray a central bank reasonably happy with its monetary settings for the meantime, with a fundamental tightening bias (albeit frustrated for now) rather than any inkling toward a bias to cut the OCR any further. The latter would have to mean a seriously collapsed world economy, and substantive international funding problems. While a risk, this is not our central forecast. The other thing we hope gets due coverage from the FSR is its arms-length perspective on bank margins. Yes, these appear to be rising (partly as the natural consequence of borrowers migrating toward the traditionally highermargined floating rates). However, it s also the case that banks net-interest margins hit a long-term low during the depths of the recent downturn, and so are for the most part simply recovering from those nadirs. Just an hour after the FSR, we ll be checking out the Government s September-quarter accounts. Is the fiscal situation improving as much as expected, following the big deficit of 2010/11 (half-owing, as it was, to the earthquakes)? In an underlying sense, we suspect yes Mar-91 Mar-93 Mar-95 Mar-97 Mar-99 Mar-01 Mar-03 Mar-05 Mar-07 Mar-09 Quarterly Source: RBNZ To judge this, we will, as usual, cut to the OBEGAL (Operating Balance excluding Gains and Losses), while also looking to see how the tax take is going, compared to the plan as outlined in the late-october PREFU. Still, we ll also need to brace for the accounting losses that will need to be booked on the NZ Superannuation Fund (NZSF). The NZSF has dropped about $2.4b, or 13%, through the September quarter, to be little different to where it was back in July Easy come, easy go. Indeed, since its inception, back in 2003 so through the big ups as well as downs it has returned 0.5% per annum above the risk-free rate. As for the political debates and polls these would seem to be cementing the lead of the incumbent National party, and its leader, Prime Minister John Key. The real information is in the policies being announced by the assorted political parties. Some stripes are beginning to be revealed. We re keeping these in mind in order to formulate, probably tweak, our macro-economic views, post the election. Ann % change Total Tax Revenue six-month totals three-month totals -20 Oct-94 Oct-97 Oct-00 Oct-03 Oct-06 Oct-09 Source: NZ Treasury research.bnz.co.nz Page 1

2 As for the monthly reports, we expect Wednesday s electronic card transactions for October to lift a hefty 2.5%, importantly flattered by the crescendo of the Rugby World Cup. This is well above the market expectation of a 0.6% rise, as per the local Bloomberg poll. If we did see something like 0.6%, as the Paymark data are more in keeping with, then we d have to materially lower our grand expectations for Q4 retail activity growth. The QVNZ housing report (midday Wednesday) looks likely to be another steady-to-mixed one. Telling news on the market has already come with last week s Barfoot and Thompson results for the month of October. These showed a good bounce in sales a big relief, given the marked drop registered for September (perhaps reflecting the Rugby World Cup and delayed school holidays; also a factor in the down-up pattern in car registrations across September/October?). The B&T numbers should, in turn, provide decent support to the nationwide Real Estate Institute of New Zealand (REINZ) figures, which will probably see the light of day before this week is out mindful that Auckland statistics, as a general rule, appear to be doing the best in the regional stakes. The REINZ Stratified House Price Index will help us judge if any inflation is emerging in the housing market something not in clear evidence thus far, even in Auckland. As for Thursday morning s BNZ Performance of Manufacturing Index (PMI), this will certainly be under the microscope, given its near-stalling in September, to a seasonally-adjusted Clearly, the manufacturing sector globally has slowed to a crawl over recent months. However, nor has it skidded into obvious recession, as it did do during 2008/09. We just hope the NZ PMI holds in expansion territory. Diffusion Index, seas. adj Industry Performance Indexes Services Breakeven Manufacturing Net balance (%) Apr-04 Apr-05 Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 Apr-11 One News Colmar Brunton, Roy Morgan Consumer Confidence One-News Colmar Brunton ANZ Roy Morgan (rhs) Less touch-and-go will likely be Thursday afternoon s ANZ- RM consumer confidence index. Indeed, we expect it to hold up at around the level it clung to in October. The prospect of this has been enhanced by the fact the very latest One-News Colmar-Brunton poll of consumer confidence edged up a few points from two months ago, to a net-positive 16. Such results tend to suggest reasonable growth in household expenditure. Friday completes the local data week, with October s Food Price Index. We are factoring in a small bounce, following two months of unsurprising correction. This would drop the yearly pace to 2.6%, from 4.7%, as the GST spike from October 2010 washes out of the annual comparison. Such things, along with a sense that underlying inflation is under control, should work to bring generalised inflation expectations down from their recent heights. However, the proof on this will be in the pudding, and could yet prove problematic central to the RBNZ sticking with its tightening bias for the meantime. This is not to overlook, of course, the continued drama unfolding in Europe. While things are bad enough in respect to Greece, it s the likes of Italy and Spain that remain the biggest potential problems to think through. On this, New Zealand obviously has no control. But nor should it feel like a little biddy cork bobbing on the international high seas. There is actually a lot that can be done, policy-wise, to aid the chances of surviving, then thriving. Yet none of them is easy, or even popular. For a sense of where easy and popular policies can lead, take a leaf out of Greece s book. craig_ebert@bnz.co.nz Index Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Source: BNZ / Business NZ research.bnz.co.nz Page 2

3 Domestic Interest Rates The combination of renewed concerns over the European debt crisis and poor local data last week saw NZ yields fall. The NZ employment data for Q3 was disappointing, with employment growing only 0.2% (0.6% expected). The Q3 unemployment rate edged up to 6.6% (6.4% expected) from 6.5% previously. However the details provided some relief, with the job trends upbeat and hours worked solid. In fact, the NZ employment rate sits amongst the highest in the OECD, reflecting robust participation rates. Overall, the data will give the RBNZ more time to sit-pat at 2.50%, before eventually hiking rates sometime next year. The OIS market is currently fully priced for the first rate hike from the RBNZ in July, from June last week. Over the next 12 months, the market expects a total of around 30bps of rate hikes, down from around 40bps of hikes. We believe expectations of rate hikes from the RBNZ will ultimately be revised higher if the European debt crisis simmers down. On the global front, renewed concerns over Greece and Italy saw risk appetite wane. Indeed, our risk appetite index (scale 0 100%) fell from 43.1% to 34.5% after concerns rose Greece may exit the Eurozone. This was compounded by US non-farm payrolls rising a disappointing 80k. This sort of jobs growth will not be sufficient to see a sustained fall in the US unemployment rate. Reuters pgs BNZL BNZM Relative to its global peers, NZ 10-year yields are now trading in line with AU counterparts, around 4.30%. The NZ-AU 10-year bond spread is now at the bottom of its recent 0-35bps range. We believe risks are now tilted toward NZ yields rising relative to AU yields. The NZ-US 10-year spread rose from 2.20% to 2.30% over the past week. We see this as likely to widen again into year end as NZ long-end yield rise faster. Looking to the week ahead, the local highlight will be Thursday RBNZ six-monthly Financial Stability Report. This will no doubt reiterate NZ s economic and financial resilience in the face of ongoing global ructions; but also betray the Bank s detailed thinking in its running commentary. Offshore, we have Eurozone retail sales tonight; UK industrial production on Tuesday; Chinese CPI, industrial production and retail sales on Wednesday; Australian employment data on Thursday; and the US University of Michigan consumer confidence survey on Friday. On the cental bank calendar, the Bank of England rate decision is due on Thursday evening and several Fed members speak throughout the week. Date 90 day 04/13 05/21 2yr swaps 10yr swaps 2yr/10yr bills NZGS NZGS s/a s/a swaps(bps) 28-Oct % 2.82% 4.53% 3.19% 4.78% Nov % 2.75% 4.35% 3.10% 4.63% 153 Change (bps) mike_burrowes@bnz.co.nz Interest Rate Technicals NZD 5yr Swap Rate Outlook: Neutral MT Resistance: 4.30% MT Support: 3.61% The 5yr swap rate continues to oscillate down here. Await a breakout before entering a new position. pete_mason@bnz.co.nz NZ 2yr-5yr Swap Spread (yield curve) Outlook: Higher ST Resistance: +93 ST Support: +72 The market has broken through its previous resistance and looks to head higher. Only a close below +72 will change this view. NZD 5-yr Swap Daily NZD 2-5yr Swap Spread Daily research.bnz.co.nz Page 3

4 Foreign Exchange Market NZD/USD started last week around after the EU announced a rescue package to stem the debt crisis. While the rescue package was never expected to solve Europe s problems entirely, there was some hope it would calm markets. Any such hopes were short-lived after the Greek Prime Minister, Papandreou, announced his intentions for a referendum on the new Greek bailout package. This created speculation of a disorderly Greece default and placed further upward pressure on Italian bond yields. The renewed concerns over the European debt crisis saw risk assets suffer last week. The Euro Stoxx 50 index and MSCI world index shed 7% and 4% respectively. Our daily risk appetite index (scale 0 100%) fell from 43.1% to an intra-week low of 30.4% and is currently at 34.5%. In this backdrop, the risk sensitive NZD/USD and AUD/USD shed around 1.5% to and respectively. While the risks of a disorderly Greek default have increased over the past week, our working assumption is for Greece to remain in the Eurozone and the EU rescue package to be implemented. Should this occur, we expect NZD/USD to appreciate towards by the end of the year. Our NZD/USD fair value range has fallen almost 1 cent to over the past week, suggesting some downside risk to the currency in the near-term. Reuters pg BNZWFWDS The move lower over the past week was driven by a fall in the NZ-US 3-year interest rate differential from 2.67% to 2.65%; and fall in our weekly risk appetite index from 43.7% to 38.9%. Meanwhile, our short-term NZD/AUD model suggests the cross is fairly valued at The fair value range is currently to However, over the next 12 months we continue to forecast a gradual appreciation in the cross to around The move higher will be driven by a sharp narrowing in NZ-AU interest rate differentials as we expect the RBNZ to raise rates by around 100bps over the next 12 months. In contrast, our NAB colleagues expect another 25bp cut from the RBA over the next 12 months. Looking to the week ahead, the local highlight will be the release of the RBNZ six-monthly Financial Stability Report on Thursday morning. Soon after the FSR, check out the Government s September quarter accounts. Is the fiscal situation improving as much as expected, following the quake-impacted 2010/11 fiscal year? As for the monthly reports, on Wednesday we have electronic card transactions for October. On Thursday, we have the BNZ PMI and ANZ-RM consumer confidence data due for release. Friday completes the data week with Food Prices for October. mike_burrowes@bnz.co.nz Foreign Exchange Technicals NZD/USD Outlook: Buy a break ST Resistance: (ahead of ) ST Support: (ahead of ) We favour buying NZD/USD on a decisive break of the downtrend line, currently at The 23.6% Fibonacci retracement level of the sell-off from to comes in at This level should form good shortterm support. mike_burrowes@bnz.co.nz NZD/AUD Outlook: Buy the break ST Resistance: (ahead of ) ST Support: (ahead of ) NZD/AUD is below the recent range of to range. Our preference would be to buy the cross on a decisive break through the 50% fibonacci retractement level at This would coincide with a break of the downtrend channel. NZD/USD Daily NZD/AUD Daily research.bnz.co.nz Page 4

5 Key Upcoming Events Forecast Median Last Forecast Median Last Monday 7 November Aus, ANZ Job Ads, October -2.1 Euro, Retail Sales, September -0.1% +0.1% Germ, Industrial Production, September -0.9% -1.0% Tuesday 8 November Aus, International Trade, September +$3.00b +$3.00b +$3.10b Aus, NAB Business Survey, October -2 Germ, Trade Balance, September b b UK, Industrial Production, September +0.1% +0.2% UK, BRC Retail Sales Monitor, October y/y -0.2% +0.3% Wednesday 9 November NZ, Electronic Card Transactions, October+2.5% +0.7% +0.2% NZ, QVNZ House Prices, October +0.7% Aus, Housing Finance, September +2.5% +1.5% +1.2% Aus, Consumer Sentiment - Wpac, November 97.2 China, CPI, October y/y +5.4% +6.1% China, Industrial Production, October y/y +13.4% +13.8% UK, Trade Balance, September - 2.1b - 1.9b US, Wholesale Inventories, September +0.5% +0.4% US, Bernanke Speaks, Small-Business Forum Thursday 10 November NZ, RBNZ Fin. Stability Report NZ, BNZ PMI (Manufacturing), October 50.8 NZ, Crown Financial Statements, September NZ, ANZ-RM Consumer Confidence, November Aus, Employment, October +10k +10k +20k Aus, RBA's Lowe Speaks, Farm Institute China, Trade Balance ($US), October +$26.1b +$14.51b Jpn, Consumer Confidence, October Jpn, Machinery Orders, September -7.1% +11.0% Euro, ECB Bulletin Euro, EC GDP Forecasts UK, BOE Policy Announcement 0.50% 0.50% 0.50% US, International Trade, September -$46.2b -$45.6b Friday 11 November NZ, Food Price Index, October +0.2% -1.0% Jpn, Tertiary Industry Index, September -0.5% -0.2% UK, PPI (core output), October y/y +3.6% +3.8% US, Mich Cons Confidence, Nov. 1st est US, Fed's Yellen Speaks, Banking Conference Historical Data Today Week Ago Month Ago Year Ago Today Week Ago Month Ago Year Ago CASH & BANK BILLS Call mth mth mth mth GOVERNMENT STOCK 11/ / / / / CORPORATE BONDS BNZ 05/ BNZ 09/ FON 04/ FON 03/ GEN 03/ GEN 03/ SWAP RATES 2 years years years years FOREIGN EXCHANGE NZD/USD NZD/AUD NZD/JPY NZD/EUR NZD/GBP NZD/CAD TWI NZD Outlook TWI Source: BNZ, RBNZ New Zealand Dollar NZD TWI NZD/USD (rhs) F/C NZD/USD research.bnz.co.nz Page 5

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