Kiwibank’s economists see a fairly strong chance that the Official Cash Rate will go as low as 0.75% next year, while they’re predicting that the Kiwi dollar, “our beautiful bird”, is about to be “broken”.
In a Kiwibank ‘Our Take’ publication, chief economist Jarrod Kerr says he’s confident interest rates will fall further “and remain at or below historic lows for a very, very long time”. The Kiwibank economists are forecasting two OCR cuts this year, starting in May, which would take the OCR down to 1.25% from its current 1.75%. But then there may be more.
“We’d put a 40% chance of another 50bp cut in the OCR to 0.75% in 2020, if conditions worsen. Beyond there, the RBNZ could cut to 50bps, and would entertain the use of QE, currency intervention, and firing up Government investment.
“The RBNZ’s QE could buy Govt bonds with the understanding the Govt ramps up fiscal investment. And the RB can easily print and sell the currency. But we’re still quite some way away from entertaining QE.
“The point here is, we have plenty of ammunition if needed,” Kerr says.
On the Kiwi currency, Kerr says it will do what we need it to do, when we need it most. If not, the RBNZ will intervene.
“We forecast a volatile descent for the bird this year. The Kiwi should drop into the low US60s by year end. RBNZ rate cuts will accelerate the Kiwi’s decline.
“At US68c today, the risk is asymmetrically lower, in our opinion. Threats of recession offshore, could see the bird drop into the US50s.”
In explaining the current economic backdrop, Kerr says there are three bug bears frustrating the outlook for Kiwi growth.
Lack of confidence
“The first, is the lack of confidence. Firms remain wary of the outlook. A lack of business confidence may disrupt hiring and investment decisions.
“The second, is the Australian property market. The housing market is tumbling (mainly in Sydney, Melbourne and Perth). The sharp decline in Australian house prices is thought to represent a yellow canary down the coalmine for Kiwi housing. We disagree.
“The third, is the rise of populism and protectionism. We wait with baited breath on the outcome of US-China trade negotiations and Brexit. Both events spawned by a rise in populism.”
Kerr says global growth is “grinding lower”, and political risk, including Brexit and US-China trade, has sapped confidence.
“A deteriorating global outlook can quickly impact New Zealand. We don’t have to look too far for evidence. Kiwi Businesses are worried about their own outlook for activity, and profitability. The economic woes offshore are weighing on Kiwi confidence. And a lack of confidence can quickly lead to a lack of growth. The latest QSBO survey showed a marked decline in confidence.
“So the RBNZ are highly likely to step in. We expect a 25bp rate cut in May, followed by another 25bp cut in (June or) August. The markets are still exposed to a quick move.”
The chart highlights the upside, downside and central scenarios set by the RBNZ just 6 weeks ago.
Kerr says It seems we’re headed down the downside (red). The Kiwibank cash rate forecast (green) and market pricing (lighter shade of pale blue) have moved to match the downside (red) scenario.
“There’s still plenty of room to move more. Interest rates markets are about hedging risk. And once the RBNZ starts cutting, the risk is automatically titled towards the bank doing more. Indeed, we’re calling for 50bps worth of rate cuts to 1.25%. Our economy is still reasonably strong. But, if international developments worsen, the RBNZ will do more.
“We place a high 40% probability of follow-through rate cuts in 2020. Again, 50bps may be required, taking the cash rate to 0.75%. The point here is, the market will price more than the RBNZ deliver, until the cycle turns.”
“Current market pricing has a slow decline to 1.25% by mid-2020. We see the risk of a rate cut in May, followed by a rate cut in August, possibly June. [RBNZ Governor] Adrian Orr has clearly elevated the importance of OCR announcements with last week’s change in stance. So we could be at 1.25% by mid-2019 (not 2020). Beyond the middle of this year, the market will have to price in the risk of another rate cut or two.”
Kerr says the chart below highlights the current RBNZ downside scenario, current market pricing, Kiwibank’s central scenario (1.25%) and Kiwibank’s downside scenario (0.75%).
“Market pricing should move to the light blue line between the Kiwibank scenarios. The 2-year swap rate should fall to a 1.30-1.50% range. And that will lower 2-year fixed mortgage rates. The Kiwi dollar should fall too,” Kerr says.
“Our beautiful little bird is about to be broken. The Kiwi is likely to enter a downward spiral in coming weeks or months,” he says.
Up until recently, the Kiwi has been flying high. The strength of our terms of trade (strong export prices relative to soft import prices) has supported the currency.
“We’ve seen the Kiwi hit a high of 0.6970 in December, and a few retests of the high in January, February and a push to 0.6939 in March. Our flightless bird often finds herself at lofty heights. We think it’s time for a timely descent to more reasonable levels. The RBNZ provided the first airpocket with the March OCR statement, leading to a 1c drop on the day. After a slight updraft, the bird was weighed down by the QSBO survey yesterday.
Kiwi fall will lift our economy
“It will come as no surprise that a lower Kiwi currency will provide a much-needed lift to our small, open economy. The problem with currencies, is they’re a relative price. Unlike magnificent interest rates, that can all fall together, currencies are a different beast altogether. Currencies can’t all fall together. Today, we have a US Fed on hold, and talking about ending QT. So the USD is not going to be as strong as (everyone else outside the US) hoped. The UK has Brexit to contend with. The EU has the EU to contend with. And the Aussies have a housing correction to contend with.
“In order to stand out, just for a moment, we need to look relatively worse than a bad bunch to get a currency decline. Adrian [Orr] understands this. In bad times Japan will repatriate, and the Swiss have a nice hiding place.”
Kerr says if we cut our interest rates before Australia the NZ-Australia currency crossrate should fall.
“If we cut twice and signal anything can happen from here, well, all of a sudden, the USD, the Euro, the Yen, the Swiss Franc, and possibly even the Pound (ok maybe a step to far), look more attractive – at least for a little while.
“After the volatility subsides, the 50bp reduction in our interest rate advantage over much of the developed world should hold the Kiwi dollar in a lower trading range. And the 50bp reduction in the OCR takes us that much further beneath the global benchmark for interest rates, US Treasury yields.
‘The flying Kiwi descends’
“Let’s say that happens. Let’s say the RBNZ cuts 50bps. Let’s say the RBNZ leaves it’s commentary open-ended, and allows the market to price in the risk of more cuts (no harm in doing so). Then the flying Kiwi descends, and should end the year close to 60c.”
Kerr notes that in currency terms, against the “Aussie battler”, the Kiwi was “dominant – like a rampaging All Black pack trampling over a weakened Wallaby”.
“We’d love to see NZDAUD parity. But such a strong NZD/AUD hurts our manufactured exports.
“A strong NZD/AUD is great if you’re wanting to buy an Australian canary yellow cricket jersey, loose fitting for underarm bowling, with a complimentary strip of sandpaper. But generally, we prefer a weaker Kiwi/Aussie cross. Because it helps our Kiwi expats in Australia import the black jerseys.”