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Business confidence continues to flatline

Business confidence continues to flatline. The RBNZ sharpens the scissors.

Ankur Naroliya

NZ business confidence declined last quarter, supporting the need to cut interest rates sooner rather than later. The Kiwi dollar has fallen.

Trump continues to undermine the US Fed’s independence. He wants to turn the US economy into a “rocket ship”.

REINZ to report on the housing market.

Here’s our take on current events

The RBNZ is poised to cut the cash rate. Because conditions deteriorate offshore and Kiwi business confidence went in reverse last quarter . The lack of confidence amongst our business leaders points to difficult times ahead. The QSBO survey mirrors the ANZ survey, and confirms what the RBNZ must be hearing in their direct liaison with Kiwi corporates. The reduction in firms’ own activity and profitability, throw up some big red flags. Firms continue to face labour shortages, higher costs, and an inability to recover escalating costs. Profitability is being squeezed. For the RBNZ the reverse in confidence is one thing, but the deterioration in firms’ expectations for their own trading activity, is something much more of a concern. We expect the RBNZ to act. We expect a 25bp cash rate cut in May (MPS), and another 25bp cut in August (MPS), possibly June (OCR).

We’ve had a number of clients ask us: ‘how far can can the RBNZ go? They’re running out of ammunition. ’ The RBNZ could cut to 50bps (-125bps in cuts). But there are diminishing returns in cutting below 1%. If we face a severe recession and/or financial market meltdown, the RBNZ would entertain the use of quantitative easing (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 spending. 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.

Last week we released our latest financial markets note outlining our view: Blood, Sugar, Brex-Magik: markets high on risk. As Kiwi interest rates fall further below US interest rates, the Kiwi dollar should drop. We forecast a volatile descent to around 60c by September, before stabilising around 63c by year end.

Last week, President Trump took another shot at the Federal Reserve (Fed), overstepping a not-so fine line. Central banks are operationally independent of Government. Although QE has brought some a little closer together. Central bank independence is critical. Political meddling in monetary policy comes at a cost, eroding trust in the system. Trump said he would like to see the Fed pump more stimulus into the economy, undertake QE to turn the US economy into “a rocket ship”. Trump’s shot at the Fed came soon after announcing his second controversial nomination to the Fed’s Board. Stephen More and Herman Cain are both fans of Trump, and may do the President’s bidding. Trump stands in stark contrast to convention. Trump is a populist, and populism is the source of most of the risks our economy faces today. We think the Fed will remain patient, keeping rates unchanged. But pressure to cut interest rates may build.

This week is a quiet one at home. The REINZ will release the March housing market report at some stage. The housing market experience depends on where you live. In Auckland the housing market is stone cold, experiencing slight price falls. In much of the rest of the country, house prices continue to rise at double digit rates. Offshore, the ECB will publish its latest policy decision, no change is expected. The ECB has acknowledged the slowdown in the Eurozone but expects this to be temporary. There is also likely to be an emergency meeting at the European Council to look at extending the Brexit deadline.

Our chart of the week: highlights NZD/USD currency and rates
Central banks are changing course. And the RBNZ may cut rates twice. The asymmetric risks have simply become too large to ignore.

Lower interest rates are a near-certainty. And we should see a volatile descent in the Kiwi dollar.

Our beautiful little bird is about to be broken. The Kiwi is likely to enter a downward spiral in coming weeks or months. 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. If we cut before the US (highly likely), NZD/USD should fall. If we cut twice and signal anything can happen from here, well, all of a sudden, the USD looks much 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 US Treasury yields – see chart.

The Kiwi should drop into the low 60s by year end. RBNZ rate cuts will accelerate the Kiwi’s decline. At 68c today, the risk is asymmetrically lower, in our opinion.

Threats of recession offshore, could see the bird drop into the 50s. 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.

The comments below were provided by Kiwibank traders. Trader comments may not reflect the view of the bank or the research team, but geez they’re great to read.

In rates, lower is more likely.

“After a torrid week prior last week was one of consolidation, within a tight range. Last week profit takers lurking given the RBNZ induced outsized moves, pushing yields into the middle of new ranges, only to find themselves back at the lows again on the back of a much weaker QSBO. The benchmark 2 year swap is in a 1.60-1.70% range until CPI and Employment data is released. Current market pricing is -9bp of cuts for May, first full -25bp by August, and a further -20bp of cuts by mid-2020. The risks lie to further cuts if the RBNZ cut early, given 2 x 25bp should immediately be priced with a least the chance of further -25bp if they do. Several banks are now calling for a cut in May, which given the “Orr” factor should be a better than even chance, and a decent chance to have the desired NZD effect. The curve shape has found some receive side and is also consolidating, with around +10bp of steepening in the 2s5s over the past weeks to around +18bp it feels about right. The short end will remain anchored by RBNZ expectations, while mid and long end rates will be subject to offshore factors (US/China trade deal and Brexit) until domestic data hogs the limelight again on 19 April with 1Q CPI.” Ross Weston, Senior Portfolio Manager

In FX, the flying Kiwi hit a wall.

“The New Zealand dollar continued to chase the widening NZ-US interest rate differential throughout last week, ending Friday with a test of technical support levels around the low-$0.6700’s. While that downward trend looks set to continue over the longer term, the NZDUSD may find interim support this week from positive US-China trade headlines (should we receive any). In addition, US-specific data (CPI) and headlines (Fed minutes) will either slow or advance the anticipated longer-term Kiwi slide. Market pricing currently implies slightly better than even odds of a late 2019 base rate cut from the Federal Reserve, and slightly less than even odds of an early 2020 cut. Deviations from that pricing, one way of the other, will likely prompt a rapid adjustment in the NZDUSD. Looking at the other noteworthy Kiwi-crosses, NZDGBP should continue to trade its multi-month low-$0.5100’s to high-$0.5200’s range, at least until some sort of Brexit conclusion is in sight. Closer to home, NZDAUD looks to have found support in the mid-$9400’s. Further declines, or a mild retracement, for that cross this week will likely be determined by price action in hard commodities, specifically Iron Ore.” Mike Shirley, Senior Trader


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