slump or hiccup? - bnz.co.nz · pdf fileeconomic momentum good ... the worm has turned 1450...

12 February 2018

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Markets Outlook RESEARCH

Slump or Hiccup?

Market correction worrisome

But not yet significant

NZ relatively well-placed this time around

Economic momentum good

Fiscal and monetary authorities have head room to act

We have been expressing for some time now our concern

that just about every asset looks overpriced and that a

correction was long overdue. Is this that correction?

Maybe. Whether it is or not, it is a timely reminder that

asset prices of all descriptions have been running strong

for a very long time now and, accompanying that strength,

volatility has been very low.

At the root of the asset strength has been the fact that

the major global central banks have left the world awash

with cash. Not only has there been lots of it but its cost

(namely interest rates) has also been uncharacteristically

low for an extended period of time. Accordingly, lots of

cheap money has pushed up equity prices, house prices

and even such things as antiques, stamp and art

collection prices.

Now, central banks are reversing the process. The pace

of quantitative easing is slowing and, in the United States,

Canada and the UK at least, interest rates are actually

rising. Accordingly, it should come as no surprise that

assets should respond to this. And when they do there is

really nowhere to hide. Correlated price gains on the way

up means correlated on the way down.

Just how far this process goes (or for that matter when,

exactly, it all plays out) is open to debate but the signs are

increasing that a significant correction might be sooner

rather than later. At this stage, the good news is that,

despite all the hype, global equity markets (in aggregate

as measured by the MSCI) have fallen only 8%, are only

back to where they were mid-October 2017 and are still

up 9.8% on this time last year. The bad news is that if this

is the start of a correction then there could be a very long

way to go.

Does this portend the end of the world as we know it?

In one way, yes. Our developed sense of security that

asset prices can only go one way has been shattered.

This will dent confidence and force a rethink of folks’

investment strategies. This shift will become even

more extreme if sentiment towards the housing

market is also dented.

Crunch!

In Perspective

The Worm Has Turned

1450

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MSCI WorldIndex

Source: Macrobond, BNZ

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1400

1600

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70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18

MSCI WorldIndex

Source: Macrobond, BNZ

Tech Bubble

Pre GFC Bubble

AnotherBubble?

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Cash Rates

NZ RBA Fed ECB

BOE BOC BOJ

Source: Bloomberg, BNZ

Markets Outlook 12 February 2018

bnz.co.nz/research

Fiscal Headroom

That said, New Zealand is very well placed to withstand

any major correction. The RBNZ has room to cut interest

rates. The Government has plenty of fiscal headroom.

And economic momentum is likely to be sustained, to an

extent, by ongoing population growth, strong terms of

trade and ongoing excess demand for housing.

Moreover, globally, the banking sector is now much better

capitalized to withstand a shock and central banks will

be very quick to abandon any future tightening plans if

economic prospects deteriorate markedly.

We thus hold the view that this is more likely to be a

hiccup than a disaster but, equally, we caution that this is

not a time for complacency.

It will be global investor sentiment that determines the

path of asset prices in the week ahead but we’ll still be

keeping an eye on local releases for greater insight as to

the current state of the New Zealand economy.

Already we have seen the Electronic Card Transaction

data for the month of January. 2018 spending clearly got

off to a strong start with total card spending rising 0.6%

for the month. This was well above our expectations.

Retail spending continues to be supported by robust job

growth, real wage expansion and a still solid housing

market.

Ouch!

A key factor behind the ongoing strength in house prices

is the fact that new supply continues to be insufficient

to meet demand. Recent permits data are testament to

this. On Friday we see ready-mix concrete production data

which may reveal more about the strength of the broader

construction market.

Also on Friday is the BNZ-Business New Zealand PMI.

In December this tumbled to just 51.2 from 57.7 in

November. We’re hoping for a modest bounce back in

January. If we don’t get it, it will make us more nervous

about the state of New Zealand’s economic expansion.

A key driver of the expansion has been tourism. The pace

of growth has been slowing, in part because the base is

so high. Another factor might be the lack of spare capacity

in the industry. We’ll get an update on this on Thursday

with December’s Accommodation Survey in which we

expect to see further modest growth in guest nights

sufficient to see the occupancy rate continue its five

year run of record highs.

The general strength of the New Zealand economy

continues to support government revenues. Tuesday sees

the release of the Crown Accounts for December. We

expect to see a continuation of recent upside surprises

which should allow the Government some head-room

with its expansionary fiscal plans.

We get a few inflation-related insights over the week but

nothing that will set the world on fire:

- On Wednesday it’s the Food Price Index (FPI) for

January. It’s usually a big month for food price inflation

thanks to seasonal increases in fresh fruit and

vegetable prices. We have penciled in a 2.4% increase

in prices for the month. This is consistent with our

view that the CPI rises 0.5% in the first quarter of

2018. The Reserve Bank is forecasting 0.6%.

- We also get RBNZ inflation expectations data on

Wednesday. We don’t expect the one or two year

figures to deviate sufficiently from 2.0% to cause any

concern.

- On Thursday the Household Living Costs Price Index

for Q4 is released. These data are, reconfigurations of

the already released CPI so won’t affect financial

markets.

- January REINZ housing market data are on Thursday

too. Other recently produced surveys have been

suggesting that the housing market is starting to

regain some momentum. We are looking for a repeat

performance from this series.

Of course, all this domestic data will pale into

insignificance compared to developments offshore –

particularly those in global equity markets. Fasten your

seatbelts – we could be in for a bumpy ride.

[email protected]

-5

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93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22

% of GDP

Fiscal Years

Core Fiscal Balance and Net Debt

Operating balance (lhs)

Net debt (rhs)

% of GDP

* Operating balance before accounting and revaluation changes Source: Treasury, BNZ

HYEFU2017

Forecasts

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Diffusion Index (s.a.)

Monthly

Performance Of Manufacturing Index

Source: BNZ/BusinessNZ

Breakeven

Degree of expansion

Degree of contraction


bnz.co.nz/research

Global Watch

NAB survey and Australian jobs in focus

US ‘twin deficits’ a weight on USD

But equity moves most important this week

Australia

Thursday’s labour force data will be closely watched, as

markets look for any sign that the stellar job growth over

2017 will start translating into a lower unemployment rate.

The print is particularly important following RBA Governor

Phil Lowe’s speech last week, which emphasised the

importance of the labour market to the RBA’s view of

the economy. Dr Lowe called out wage growth as a

particular area of attention for the RBA, while stating

that the Bank needs to see further clear improvements in

unemployment and a rise in inflation before raising rates.

A similar message was carried last Friday’s release of the

Statement of Monetary Policy (SoMP), where the RBA

conveyed optimism about the direction of the economy,

the labour market and inflation. The RBA is predicting

the unemployment rate to decline to 5¼% by mid 2018.

While this is a touch lower than the previous SoMP, this

change reflects a slight shift in response to a lower-than-

expected December unemployment print.

Participation Has Reached Mining Boom Highs

For this month’s jobs print, NAB is expecting another

strong month of jobs growth. Our models and evidence

point to +35k jobs growth, which could also be helped by

ABS sample rotation effects.

On the unemployment rate, we expect a modest decline

to 5.4%, with a flat participation of 65.7%.

Currently, the participation rate is just shy of its record

high during the mining boom (65.8%), although the

composition of the economy is very different. Our analysis

shows that the participation rate could go higher, given

the solid growth in female participation (that is potentially

NDIS-related).

Cap. Utilisation Pointing to Lower Unemployment

The NAB monthly business survey is released on Tuesday.

While the headline business conditions and confidence

measure are always of interest, we will also be paying

attention to the labour market indicators: capacity

utilisation and wage costs as well as industry and state

trends.

The NAB capacity utilisation measure, which is highly

correlated to unemployment, has been rising, pointing to

a the risk of a lower unemployment rate in the near term.

Labour costs are yet to reach above-average rates of

inflation, although they have picked up since mid-2016.

Market Focus

This new section in the What to Watch looks at one

interesting market development that might intrigue

analysts in the week ahead.

Based on current proposals – which includes provisions

for increased military and non-defence spending in

FY2018 – the United States’ budget deficit is estimated to

blow out from around 3.4% of GDP this fiscal year to

~6% in FY18 (combining tax cuts already agreed with

fresh spending increases).

The chart below shows what the impending blow-out in

the budget deficit does to the ‘twin deficits’ (budget +

current account deficit) overlayed against the USD trade

weighted index (Fed Majors) with a one year lag.

The message is that twin deficits are already returning as

a significant USD headwind (the logic being that sharply

increased external financing requires some combination

of higher yields and a weaker dollar to attract more

overseas capital).

We look to be undergoing a corrective bounce in the

USD linked to current market machinations and higher

US yields, but this shouldn't detract from what looks

to be secular downturn in the USD, already underway.


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US Twin Deficits and USD

Our view of the USD having entered a multi-year

downtrend is one reason we nudged our AUD/USD

forecasts slightly higher this week (0.75 at end 2018 from

0.73 previously). A less benign risk environment and rates

differentials continue to justify lower AUD/USD levels.

US

Wednesday sees both US CPI and retail sales figures for

January. Markets will be especially sensitive to any new

inflation warning after the spike in average hourly earnings

spooked markets. The week will particularly quiet for Fed

speakers, after this week’s bonanza. President Mester –

a voter - is speaking on Tuesday.

UK

January’s CPI prints on Tuesday, which the markets will

home in on following BoE Governor Mark Carney’s recent

remarks on the BOE’s rising inflation concerns. Carney’s

comments that “monetary policy would need to be

tightened somewhat earlier and by a somewhat greater

extent over the forecast period” means that the markets

will also be alert to other BoE speak in the coming days

and weeks. Friday’s retail sales data are expected to

reveal only a partial rebound after last month’s large

decline.

Eurozone

GDP on Wednesday and a number of ECB speeches are

scattered through the week. Markets are again on the

lookout for signs of ongoing strength in the European

economy, and any hint in the speeches of an earlier

(pre-September) wind back of QE policies.

Canada

With last Friday’s labour market report proving softer than

anticipated, we’ll also be looking at Thursday’s speech by

BoC’s Schembri, for an update to the BoC’s view.

[email protected] / [email protected]


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Fixed Interest Market

NZ interest rates moved lower last week and the yield

curve steepened further. NZ interest rates continued to

decline relative to the US, with the spread between 10

year NZ bonds and US Treasuries now around 10bps, its

tightest level since the 1990s. Turbulence in global equity

markets didn’t have much sustained impact on 10 year

Treasury yields, which ended the week near unchanged.

The RBNZ Monetary Policy Statement (MPS) last week

was in line with our expectations as the Bank kept its OCR

track unchanged and retained its very mild tightening bias.

But the Bank lowered its CPI forecasts significantly and it

now expects to reach 2% in the middle of 2020, some

two years later than previously expected. There was a

small decline in the 2 year swap rate after the MPS as the

market further reduced the probability of a rate rise this

year (a November hike is now priced at 37%). The other

highlight last week was the labour market report which

showed a small decline in the unemployment rate but a

disappointing pick-up in wage growth (much like what we

have seen in many countries internationally).

We expect CPI and GDP to be lower than the RBNZ’s

forecasts over the coming two quarters and it’s

conceivable the market starts to price the risk of rate cuts

this year. For the moment, this still looks a long shot

given the strengthening global growth backdrop and our

expectation that the domestic economy (and inflation) will

pick-up after an early year lull. We expect the 2 year swap

to trade a 2.10% - 2.20% range for the time being.

The 3 month bank bill rate drifted up a few bps last week,

to 1.91%, and is now back at levels last reached in

November. In the US, FRA/OIS spreads have widened out

this month and that may have contributed to pushing up

the NZ 3 month bank bill rate. NZ banks can issue

commercial paper in USD and swap the proceeds to NZD

as an alternative to raising short-term domestic funding,

so there is a link between the two (the rate at which NZ

banks can issue CP offshore will be influenced by FRA/OIS

spreads). Another interpretation of the rise in the 90 day

bank bill rate is that the apparent surplus of liquidity

among domestic banks is starting to diminish.

Looking to the week ahead, the focus will centre on the

release of US core CPI. The market expects a 0.2%

increase for January, lowering the annual rate slightly to

1.7%. Given the market’s growing anxiety about the

prospect for higher US wage and price inflation, the

release will probably generate a significant market

reaction if it is different from the consensus. A stronger

than expected CPI release will probably see the US 10

year rate push on towards 3% in the first instance. But

it’s also quite possible that a stronger CPI number

generates a further sell-off in global equities which could

Reuters: BNZL, BNZM Bloomberg:BNZ

then lend support to US Treasuries as a ‘safe haven’

investment. Notwithstanding recent equity market

volatility, we still think there are upside risks to US and NZ

longer-term interest rates. In that environment, we retain

a steepening bias for the NZ yield curve.

Locally, we don’t have much in the way of economic data

this week to move local rates markets. The NZDMO is

scheduled to tender another $200m of the 2025 NZGBs.

Most NZGBs continue to trade special in repo, implying

the market is positioned short and suggesting the tender

should go reasonably well.

We remain on watch for any announcement from the

NZDMO about the 2029 bond syndication. However,

given recent market volatility and the upcoming Chinese

New Year holiday period, which starts later this week, we

would be surprised if we got an announcement this week.

If global markets settle down, we think a potential

issuance window for the syndication opens mid next

week, after the end of the Chinese New Year break.

90 Day Bank Bill Rate Has Risen Over The Past Week

[email protected]

1.8

1.9

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2.2

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Jan-17 Apr-17 Jul-17 Oct-17 Jan-18

2yr swap

Source: BNZ, Bloomberg

2 year swap and 90 day bank bill rate

90 day bank bill rate

Current Rates/Spreads and Recent Ranges

Current Last 3 -weeks range*

NZ 90d bank bills (%) 1.91 1.88 - 1.91

NZ 2yr swap (%) 2.16 2.15 - 2.26

NZ 5yr swap (%) 2.74 2.70 - 2.79

NZ 10yr swap (%) 3.29 3.22 - 3.32

2s10s swap curve (bps) 113 103 - 114

NZ 10yr swap-govt (bps) 33 32 - 35

NZ 10yr govt (%) 2.96 2.90 - 2.99

US 10yr govt (%) 2.85 2.61 - 2.88

NZ-US 10yr (bps) 11 11 - 32

NZ-AU 2yr swap (bps) 15 7 - 18

NZ-AU 10yr govt (bps) 7 4 - 15

*Indicative range over last 3 weeks


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Foreign Exchange Markets

Reuters pg BNZWFWDS Bloomberg pg BNZ9

Currency markets are surprisingly well behaved in the

face of the turbulence seen in global equity markets.

It is typical during an equity market meltdown and sharp

rise in the VIX index for the NZD to come under significant

pressure, but the currency market has been trading in an

orderly fashion and the 0.2% fall in the TWI last week was

insignificant against that backdrop.

We might even put some of that NZD moderation down to

the RBNZ’s MPS last Thursday, which didn’t surprise most

with its unchanged outlook for policy. But some offshore

watchers seemed disappointed with the Bank’s relaxed

attitude to the inflation outlook and were looking for a

more hawkish tilt. The NZD was modestly weaker after

the MPS. Against the 5-majors, the NZD was down

slightly against the USD and JPY for the week but ended

up slightly higher against AUD, EUR and GBP.

Our risk appetite index has fallen below the neutral 50%

mark for the first time in 20-months, after spending much

of that time well above that mark. Over the last two

weeks the index has plunged from a lofty 85% to 48%

and over that time only 1 cent has been shaved off the

NZD, compared to our model which suggests that the

NZD “deserved” to fall by 3½ cents. Our NZD model

estimate has been slammed down to below the USD 0.70

mark, with the VIX Index at elevated levels, but fair value

could well settle higher once markets settle. Plugging in

a VIX reading of 20, close to its long-term average, would

lift fair value by about 1 cent.

The market “shock” so far is rather specific to equity

markets. Global equity markets, particularly US stocks,

were way in over-bought territory after their massive run-

up. Complacency was rife, evident by the proliferation

of “short-volatility” trades, and sharemarket volatility has

been exacerbated by the unwinding of those positions.

Some of the hit to equity markets can be traced to

concerns about the outlook for US inflation and its rising

fiscal deficit, which has seen the US 10-year Treasury

yield reach a 4-year high. The bond market is not proving

to be a safe-haven in this environment, with upward risk

to interest rates still justified on fundamental economic

grounds.

So this isn’t your usual hiccup in risk appetite. To be sure,

there has been some flow to safe-haven assets, but no

panic has set in. Our view has been for a broadly-based

decline in the NZD this year, but moderated to the extent

that the global economic outlook remains sound, limiting

the downside to commodity prices which the NZD is

sensitive to. Our view hasn’t changed.

In the week ahead, obviously we’ll be keeping a close eye

on global equity markets. Despite the NZD holding up

well in the midst of the plunge in risk appetite, the

currency’s correlation (ie. directional movements) with risk

appetite has picked up and another burst of market

volatility would be NZD-negative.

The local data calendar only has second-tier releases.

With heightened sensitivity on inflation, the US CPI

release Wednesday night is the key global economic

release to watch. Another positive surprise of 0.3% m/m

for the month for the core measure could send bond

yields higher and equity markets (and the NZD) lower.

There are a number of other US releases including retail

sales, industrial production and housing data.

UK CPI is the other key release to watch. Last week’s

BoE outlook was surprisingly hawkish ahead of key Brexit

talks. Governor Carney said UK rates may need to rise at

a steeper pace than previously thought, with demand

growth expected to exceed the diminished supply growth.

These comments only temporarily supported GBP, with

Brexit headlines dominating. A strong CPI result would

add to the probability of a rate hike by May and support

our call for a weaker NZD/GBP cross rate through the year.

Risk Appetite Index Falls Below the Neutral 50% Mark

10%

20%

30%

40%

50%

60%

70%

80%

90%

2012 2013 2014 2015 2016 2017 2018

BNZ Risk Appetite Index

Source: BNZ, Bloomberg

Cross Rates and Model Estimates

Current Last 3 -weeks range*

NZD/USD 0.7247 0.7180 - 0.7440

NZD/AUD 0.9277 0.9030 - 0.9300

NZD/GBP 0.5246 0.5140 - 0.5270

NZD/EUR 0.5917 0.5850 - 0.6010

NZD/JPY 78.88 78.10 - 81.60

*Indicative range over last 3 weeks, rounded figures

BNZ Short-term Fair Value Models

Model Est. Actual /FV

NZD/USD 0.6940 4%

NZD/AUD 0.9040 3%

[email protected]


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Technicals

NZD/USD

Outlook: Trading range

ST Resistance: 0.7350 (ahead of 0.7440)

ST Support: 0.7150 (ahead of 0.7050)

Near term support is around 0.72 and the 200-day moving

average of 0.7150, although neither levels are particularly

solid markers. First level of resistance around 0.7350,

ahead of more solid resistance at 0.7440.

NZD/AUD

Outlook: Trading range

ST Resistance: 0.9300 (ahead of 0.9400)

ST Support: 0.9040 (ahead of 0.8975)

Last week we saw some resistance emerge just above the

0.93 mark. A sustained break opens up 0.94 and then a

step-up to 0.9640. Support levels are currently more than

2 cents below spot.

[email protected]

NZ 5-year Swap Rate

Outlook: Higher

ST Resistance: 2.93

ST Support: 2.70

Support held last week and now comes in at 2.70. Expect

a move to 2.93 area.

NZ 2-year - 5-year Swap Spread (yield curve)

Outlook: Steeper

ST Resistance: +72

ST Support: +49

Breaking higher expect a move towards +72. Trendline

support now comes in at +49.

[email protected]

NZD/USD – Daily

Source: Bloomberg

NZD/AUD – Daily

Source: Bloomberg

NZ 5-yr Swap – Daily

Source: Bloomberg

NZ 2yr 5yrSwap Spread – Daily

Source: Bloomberg


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Key Upcoming Events

Forecast Median Last Forecast Median Last

Monday 12 February

NZ, Electronic Card Transactions, Jan +0.3% +0.2%

China, (circa) Aggregate Financing (RMB), Jan CNY1,140b

Tuesday 13 February

NZ, Crown Financial Statements, 6m-ended-Dec 2017

Aus, RBA's Ellis Speaks, ABE Conference

Aus, NAB Business Survey, January +11

UK, CPI, January y/y +2.9% +3.0%

US, Fed's Mester Speaks

US, NFIB Small Business Optimism, January 105.7 104.9

Wednesday 14 February

NZ, RBNZ 2yr Inflation Expectations, Q1 +2.02%

NZ, Food Price Index, January +2.4% -0.8%

Aus, Consumer Sentiment - Wpac, Feb 105.1

Jpn, GDP, Q4 1st est +0.2% +0.6%

Euro, Industrial Production, December +0.1% +1.0%

Euro, GDP, Q4 2nd estimate +0.6% +0.6%P

US, CPI ex food/energy, January y/y +1.7% +1.8%

US, Retail Sales, January +0.2% +0.4%

US, Business Inventories, December +0.3% +0.4%

Thursday 15 February

NZ, REINZ Housing Data, January

Aus, Employment, January +35k +15k +35k

Aus, Unemployment Rate, January 5.4% 5.5% 5.5%

Jpn, Industrial Production, Dec 2nd est +2.7%P

Jpn, Machinery Orders, December -2.3% +5.7%

Euro, Trade Balance, December s.a. +€22.3b +€22.5b

US, Jobless Claims, week ended 10/02 228k 221k

US, Philly Fed Index, February +22.0 +22.2

US, Empire Manufacturing, February +18.0 +17.7

US, PPI ex-food/energy, January y/y +2.1% +2.3%

US, Industrial Production, January +0.2% +0.9%

US, NAHB Housing Index, February 72 72

Friday 16 February

NZ, Concrete Production, Q4

NZ, BNZ PMI (Manufacturing), January 51.2

Aus, Lowe Testifies

UK, Retail Sales vol., January +0.6% -1.5%

US, Housing Starts, January 1,231k 1,192k

US, Mich Cons Confidence, Feb 1st est 95.5 95.7

Historical Data

Today Week Ago Month Ago Year Ago Today Week Ago Month Ago Year Ago

CASH & BANK BILLS

Call 1.75 1.75 1.75 1.75

1mth 1.80 1.80 1.77 1.85

2mth 1.85 1.85 1.82 1.94

3mth 1.91 1.89 1.88 2.03

6mth 1.93 1.92 1.92 2.07

GOVERNMENT STOCK

03/19 1.77 1.78 1.78 2.18

04/20 1.85 1.94 1.98 2.40

05/21 2.04 2.13 2.15 2.54

04/23 2.38 2.45 2.41 2.81

04/25 2.72 2.76 2.67 3.12

04/27 2.95 2.98 2.87 3.21

04/33 3.32 3.34 3.19 3.56

04/37 3.47 3.50 3.34 3.88

GLOBAL CREDIT INDICES (ITRXX)

Australia 5Y 66 59 54 89

Nth America 5Y 60 56 47 63

Europe 5Y 56 47 45 73

SWAP RATES

2 years 2.15 2.18 2.22 2.35

3 years 2.36 2.40 2.41 2.60

4 years 2.56 2.59 2.58 2.80

5 years 2.73 2.76 2.73 2.96

10 years 3.27 3.32 3.23 3.47

FOREIGN EXCHANGE

NZD/USD 0.7240 0.7265 0.7300 0.7175

NZD/AUD 0.9276 0.9222 0.9165 0.9392

NZD/JPY 78.80 79.24 80.69 81.61

NZD/EUR 0.5917 0.5875 0.5953 0.6772

NZD/GBP 0.5241 0.5204 0.5293 0.5729

NZD/CAD 0.9117 0.9109 0.9073 0.9380

TWI 74.8 74.9 75.2 78.6


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Stephen Toplis

Head of Research

+64 4 474 6905

Nick Smyth Interest Rates Strategist

+64 4 924 7653

Craig Ebert

Senior Economist

+64 4 474 6799

Doug Steel Senior Economist

+64 4 474 6923

Jason Wong Senior Markets Strategist

+64 4 924 7652

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