BNZ Markets Outlook. Businesses, Not Households, Drive The Slowdown. 4 July Page 1

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Lucinda Newman
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1 BNZ Markets Outlook 4 July 2005 Businesses, Not Households, Drive The Slowdown NZ economy looking shaky Businesses feeling the pain as profit margins pressured Householders, to date, reasonably unaffected But complacency inappropriate Over the past few years the stars have been aligned for the New Zealand economy, resulting in its most impressive run of growth in decades. High commodity prices, large net inflows of new migrants, and the lagged impact of a weak New Zealand dollar saw corporate, farm, and household incomes push markedly higher. As a result, big gains were seen in asset prices, particularly house, farm, and stock prices, providing significant wealth gains. However, most recently, the economy has started to look a little shaky. Certainly headline growth has slowed markedly in the two most recent releases of the national accounts, with the economy expanding by only 2.5% in the year to March Compare this with a peak of 5.8% just three quarters earlier. But someone forgot to tell householders that growth is under pressure. Consumer confidence measures, while showing some softening, are still at very robust levels. Who can blame them for feeling good about life when house prices are up 11.0% in the past year, unemployment is near record lows and wages are climbing. The steady build up in the rate of annual wage improvement will have householders rubbing their hands with glee. Especially when it seems likely that labour will remain a scare resource for some time yet, keeping the bargaining ball firmly in the employee s side of the court. In addition, the Government s Working For Families package is pumping more into the household sector. net % who are positive Business and Consumer Confidence Firms, on the other hand, know all too well that life is getting tough. Those exporters who are not enjoying the substantial benefit of high international commodity prices are feeling some pain. Forestry and fishing exporters are the obvious examples in the primary sector, but manufacturing firms and tourist operators revenue streams are also under pressure. This was certainly evident in the first quarter GDP figures, with manufacturing activity and services exports very weak indeed. But problems in corporate New Zealand are more widespread than this. Cost pressures are starting to come through in many areas, putting the squeeze on margins. Wage costs, are accelerating, transport costs are up, and input costs, more generally, are bubbling higher. In all, producer price input costs were up a hefty 4.2% in the year to March. No wonder then that business confidence is falling. In the latest National Bank Business Outlook businesses expectations for their own output fell to the weakest reading since June 2000 to a level consistent with annual growth below 1.5%! Unsurprisingly, profit expectations are looking sick. Divergence between the fortunes of householders and firms is hardly unusual. However, it is unusual for such divergence to last. As such, expect the concerns of corporates, especially if they are realised, to eventually spread to consumers via a rising unemployment rate. Once this occurs New Zealand s slowdown will well and truly be in place, and the economy will, in all likelihood, record sub-par growth for an extended period of time. Turning to the week ahead, data wise, New Zealand is going to be a very quiet place indeed. The only scheduled release of note is June s ANZ commodity price index on Wednesday. Through June lamb and beef prices were basically flat on global markets, as were dairy prices. As such, expect the ANZ index to be broadly unchanged, thereby remaining at an extremely inflated level Consumer Business The only other question of note will be whether Auckland can pull off a victory on Tuesday night, and by just how much the All Blacks will win on Saturday. dean_ford@bnz.co.nz Source: NBNZ, Colmar Brunton Page 1

2 Domestic Interest Rates BNZ Telerate pgs 2473, 2474 Reuters pgs BNZL BNZM Our swap yields opened 2-5 points higher across the curve this morning on the back of stronger than expected manufacturing data out of the US on Friday night. The Institute for Supply Management s report on US manufacturing in June came in at 53.8 compared to an expected A result above 50 is indicative of growth and this, combined with a materially stronger than expected number, saw the US 10 yr bond climb 13 basis points to 4.05%, the largest move since March. We expect to see the bias towards higher yields this week with the US 10 year breaking through the all important technical level of 4.00%. Despite this we still see forward start or longer dated hedges as good value with the curve the most inverted it has been since the OCR was introduced in March With the adoption of International Financial Reporting Standards (IFRS) approaching, several issues in relation to IFRS39 are surfacing. Last week a couple of clients expressed concerned over the 5 point mismatch between BKBM bid and BKBM FRA in relation to hedge effectiveness between floating rate debt and interest rate swaps. A potential solution to this is to increase the fixed leg of new/existing swaps by 5 points and set the floating leg of the swap against BKBM bid rather then FRA. In terms of the week ahead, the focus this week in the US will be the June non-farm payrolls report on Friday night, May factory orders on Tuesday will also be of some interest. Interest rate announcements are expected in both the UK and Eurozone on Thursday, although neither is expected to change rates. Domestically things are very quiet with the only item of note being Wednesday s commodity export price data for June. In Australia, the May trade balance is due for release on Monday and June unemployment figures on Thursday. sarah_j_crowe@bnz.co.nz % Ten Year Bond 90 Day Bank Bills NZ Interest Rates Forecasts Source: BNZ Interest Rate Technicals NZD 5-year Swap Rate Outlook: On Watch ST Resistance: 6.45% ST Support: 6.75% The recently volatile 5y NZD swap moved quickly back to our short-term resistance level. Technically, we find ourselves near the previous low in rates. Due to this we are watching carefully to see if this level holds, or we are set for a push lower in yield confirming the new downtrend in rates. scott_marsh@bnz.co.nz NZ 3 year-10 year Swap Spread (yield curve) Outlook: On Watch ST Resistance: PAR ST Support: 20 basis points (inverted) The 3y-10y spread has continued to invert, now sitting at the previous support. We expect the spread to do some work around this level, with a further inversion setting up a test of the 20pt short-term target. NZD 5-yr Swap Daily NZD 3-10yr Swap Spread Weekly Page 2

3 Foreign Exchange Market BNZ Telerate pgs 2460, 2461 Reuters pg BNZWFWDS The NZD closed last week on a poor note, plunging to an 8-month low of on Friday, succumbing to a surging USD and narrowing interest rate differential. Earlier in the week, the slide in the NZD was mostly triggered by domestic news of weakening economic growth in the shape of another poor NBNZ business confidence reading in June and sharp widening in the trade deficit in May. However, Friday s stumble was a product of better economic news out of the US serving to further erode New Zealand s interest-rate advantage over the US. At the 2-year maturity, this is now down to around 230bps, from over 300bps just six months ago. It has become clear through the Fed s statement accompanying its latest 25bps rate hike to 3.25%, as well as upbeat readings on manufacturing activity and consumer confidence in June, that US interest rates will continue to rise over the rest of the year, towards, in our opinion, 4.00%. In response, investors are selling down the currencies of economies which look to be showing signs of slowing and the need for lower interest rates at some point over the next year. Both the NZD and GBP fall into this category and investors are selling these currencies both outright and also versus the CAD (since the Bank of Canada is one of the few central banks expected to raise interest rates apart from the Fed). New Zealand s rapidly rising current account deficit is an additional red flag to investors, especially as the increased funding requirements will be taking place as the NZD s yield advantage shrinks. The convincing break of / now means that there are not many lines of support until around Indeed, is the 61.8% retracement of the NZD s range of the past year, and we continue to expect this to trade by year end. sue_trinh@bnz.co.nz FX Strategy Targets 4/07/2005 Sep-05 Dec-05 Jun-06 Australian Dollar AUD/USD New Zealand Dollar NZD/USD Japanese yen USD/JPY Euro EUR/USD British Pound GBP/USD Swiss Franc USD/CHF Canadian Dollar USD/CAD Foreign Exchange Technicals NZD/USD Outlook: Rate Lower ST Resistance: ST Support: The last week has seen the break of our long-term rising trend that has been intact since Once broken we have seen an extension of the move confirming our strong downward bias. While we may see some consolidation around these levels, we expect the downside to be tested in the short-term. scott_marsh@bnz.co.nz NZD/AUD Outlook: Rate Lower LT Resistance: LT Support: After seeing the NZD/AUD push up to our target level the cross has continued to push lower. The cross has broken our short-term support and we look for a test of our long-term support over the next few weeks. NZD/USD Weekly NZD/AUD Weekly Page 3

4 Key Upcoming Events Forecast Median Last Forecast Median Last Monday 4 July Aus, International Trade, May -$1.5b -$1.40b -$1.33b Aus, ANZ Job Ads, June -7.3% Euro, PPI, May -0.1% +0.4% US, Holiday, Independence Day Tuesday 5 July Euro, PMI Services, June Euro, Retail Sales, May +0.4% -1.2% Germ, Retail Sales - vol, May -0.3% UK, CIPS Services, June US, Factory Orders, May +3.0% +0.9% Wednesday 6 July NZ, ANZ Comdty Prices ($NZ), June -0.1% Aus, RBA Rate Announcement 5.50% 5.50% 5.50% Jpn, Leading Index, May prelim 40.0% 31.8% Germ, Factory Orders, May prelim +1.1% -2.9% UK, Industrial Production, May -0.1% +0.9% US, ISM Non-Manuf, June Thursday 7 July Aus, Employment, June +15k +2.5k +14k Aus, Unemployment Rate, June 5.1% 5.2% 5.1% Euro, ECB Rate Decision 2.00% 2.00% 2.00% UK, BOE Rate Decision 4.75% 4.75% 4.75% US, Jobless Claims, week ended 2/07 320k 310k Can, PMI, June Friday 8 July Jpn, Household Spending, May y/y -2.0% -3.0% Jpn, Machinery Orders, May -1.9% -1.0% Germ, Industrial Production, May prelim -0.5% +1.3% US, Consumer Credit, May +$4.0b +$1.3b US, Wholesale Inventories, May +0.5% +0.8% US, Non-Farm Payrolls, June 192k +78k US, Unemployment Rate, June 5.1% 5.1% Can, Employment, June +20k +35k All, OECD Leading Indicator, May y/y flat 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 02/ / / / / / / / CORPORATE BONDS BNZ 09/ BNZ 09/ BNZ 09/ HNZ 11/ HNZ 11/ TRP 02/ TRP 12/ CORPORATE SWAP RATES 1 year years years years FOREIGN EXCHANGE (Against USD) NZD AUD GBP CAD EUR CHF YEN TWI NZD Outlook TWI NZD/USD (rhs) NZD TWI New Zealand Dollar Forecasts NZD/USD Source: BNZ, RBNZ Page 4

5 Contact Details Main Offices Wellington 1 Willis Street PO Box 2392 Wellington, New Zealand Telephone: +(64 4) FI: Fax: +(64 4) Auckland 125 Queen Street PO Box 2139 Auckland, New Zealand Telephone: +(64 9) Toll Free: Christchurch 129 Hereford Street PO Box 1461 Christchurch, New Zealand Telephone: +(64 3) Toll Free: Sydney Level 27, 255 George Street Sydney, New South Wales 2000 Telephone Facsimile London 88 Wood Street London EC2V 7QQ Telephone: +(44 20) Fax: +(44) New York National Australia Capital Markets LLC Level 28, 245 Park Avenue New York, NY Toll free: Telephone: +1(212) Fax: +1(212) Hong Kong 1 Pacific Place 88 Queensway, Hong Kong Telephone: +(85 2) Economic Research New Zealand Stephen Toplis Head of Research +(64 4) Craig Ebert Senior Markets Economist +(64 4) Dean Ford Markets Economist +(64 4) Australia (NAB) Alan Oster Group Chief Economist +(61 3) Rob Henderson Chief Economist, Markets +(61 2) Jeff Oughton Head of Economics Australia +(61 3) Tom Taylor Head of Economics International +(61 3) London (NAB) Tom Vosa Head of Market Economics Europe +(44 20) Kris Bernie Dollar Bloc Economist +(44 20) Strategy New Zealand Sue Trinh Currency Strategist +(64 4) Australia (NAB) Peter Jolly Head of Research +(61 2) John Kyriakopoulos Currency Strategist +(61 2) Foreign Exchange Fixed Incomes/ Derivatives Wellington Sydney (61 2) London (44 20) New York Hong Kong +(85 2) (85 2) HOUR FOREIGN EXCHANGE SERVICE Phone Toll Free 6am to midnight NZT Wellington Office am NZT London Office Mike Kinnell ANALYST CERTIFICATION: The person or persons named as the author(s) of this report hereby certify that the views expressed in the research report accurately reflect their personal views about the subject securities and issuers and other subject matters discussed. No part of their compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in the research report. Research analysts responsible for this report receive compensation based upon, among other factors, the overall profitability of the Markets Division which is part of the Institutional Markets & Services division of National Australia Bank Limited, a member of the National Australia Bank Group (the National ). The views of the author(s) do not necessarily reflect the views of the National and are subject to change without notice. The National may receive fees for banking services provided to an issuer of securities mentioned in this report. 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Bank of New Zealand strongly recommends readers seek independent legal/financial advice prior to acting in relation to any of the matters discussed in this publication. Neither the Bank of New Zealand nor any person involved in this publication accepts any liability for any loss or damage whatsoever may directly or indirectly result from any advice, opinion, information, representation or omission, whether negligent or otherwise, contained in this publication. US DISCLAIMER: This information has been prepared by National Australia Bank or one of its affiliates or subsidiaries (collectively, NAB ). If it is distributed in the United States, such distribution is by National Australia Capital Markets, LLC (NACM) which accepts responsibility for its contents. Any U.S. person receiving this information wishes further information or desires to effect transactions in the securities described herein should call or write to NACM, 200 Park Avenue, New York, NY (or call (877) ). 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Interest Rate Research

RESEARCH Interest Rate Research 2 March 218 NZ Bank Bill-OIS and FRA-OIS Spreads An Update Increases in US Libor-OIS and the Australian equivalent have filtered through into wider NZ FRA- OIS spreads over