Reserve Bank of New Zealand Rate Decision
Looking at economic factors
While markets prepare again for another RBNZ decision with speculation of a cut, a number of economic factors are working in favor and against a decrease. The 90 day Bank Bill and Overnight rate are correctly positioned, New Zealand’s House Price Index Q V Q is running above 1year, 5 and 96 month averages and is currently at the highest levels in 31 months, while annual averages trade above a long-term trend line dating to December 1990, but remain below the 1 and 5 year averages.
Mortgage interest rates however are at the highest levels while two year Fixed Rate Mortgages are bumping against 1 and 5 year averages. CPI and NZD exchange rates Real and Nominal on a Trade Weight basis are all severely below trend. Below trend CPI is not the factor of Petrol – although it assisted – but rather trends are found in the Inflation Tradables and Non Tradables. Tradables are the current driving force to lower OCR or remain on hold despite Real GDP at above trend growth.
GDP above current growth rates is found the commonality in all central banks and in all economies. Current Real GDP annual averages in New Zealand, Europe, US, and the UK are all running above long term trends while Australia is bumping against 1 year averages. Japan just lifted off from zero growth to achieve above trend readings. For New Zealand to sustain GDP growth, the relationship between tradables and non tradables must meld in relation to export prices and exchange rate levels.
The RBNZ highlighted both aspects in the April 30 Statement. Current export prices for an export-oriented economy as New Zealand are at a severe disadvantage in relation to the exchange rate. Before export prices and exchange rates settle however Inflation Tradables Vs Non Tradables must be addressed first because that is where is found prices and demand within New Zealand. If the Tradable and Non Tradable relationship deviates further to cause weak demand in New Zealand then the RBNZ faces a must cut situation to spur growth. Both relationships, Export Prices Vs Exchange rates and Tradables Vs Non Tradables, are a polemic but in the short to medium term and not yet a cause to lower OCR for the next quarter especially when the 90 Day rate is correctly positioned.
The new growth approach of Central Banks
What is obvious from the masses of data under constant review is many central banks are no longer working in post 2008 crisis mode. A new phase of growth and repair is the new norm. The current changes are slow yet structural and will take a few quarters since most economies were hit exorbitantly hard. New Zealand is no different in this regard as OCR was 8.25 at crisis time and dropped to 2.50 lows.
For the past 7 years, central banks operated in defensive mode and adopted questionable policies to hold economies from collapse but no longer since growth and the future is the new priority. In markets, structural changes are seen in rotations from bond safety exodus to risk on equities and other risk financial instruments. Why focus on New Zealand and the RBNZ? Because both always either lead the way towards recovery or signal downturns long in advance. Despite OCR 2.50 lows as an example, the RBNZ hiked already three times and all occurred in 2014.
Overnight Vs 90 Day Rates
The Overnight rate trades between short to intermediate averages between 3.35 – 2.69 while the 90-day in the same time frame trades between 3.62 and 2.97. The overnight rate encompasses averages from 1 year to 30 beginning at 3.35, 2.69, 4.44, 5.51, 6.02 (25Y) and 7.89. Targets for the Overnight rate range from 1 year to 30 beginning at 3.49, 3.06, 2.09, 2.92, 3.22 and 2.70. The 90-day averages in the same time frames range from 3.62, 2.97, 4.75, 5.71, 6.26 and 13.65 for the 30 year. Targets begin at 3.53, 3.35, 2.34, 3.47, 3.66 and undetermined for the 30 year.
Targets are inflection points yet guides and vital to align the entire 30 year distributions in present views. The 5 year average for both the Overnight and 90 day Rate is misaligned and should be much higher. The 90 day rate is comfortable within the 3.62 – 2.97 range. If an adjustable OCR cut lower is needed from 3.50 then the range sustains. An OCR move lower, evidenced by positions of the Overnight and 90 day rate, would be corrective as longer term averages become oversold. Further, from the three rate hikes in 2014, any move lower is temporay and corrective as the trend in OCR is higher over time. Where the 90 day should be located based on Knut Wiksell’s Neutral Interest rate principles is above 3.62 so a higher range between 3.62 – 4.75 would serve the perfect economic range at least short term. Wiksell’s actual principles is the 90 day rate should be above the 20 year average at 5.71 to then range between 5.71 and the 25 year average at 6.26. An interest rate above the 20 year average is an economy in good equilibrium.
10 and 2 Year Yield, and 10 Vs 2’s Spread
10 year averages from 1- 30 years align as 3.87, 4.35, 5.11, 5.88, 6.47 and 7.91. Targets from 1 – 30 years include 3.44, 3.60, 4.13, 4.72, 4.67 and 4.24. From either the last monthly average April 2015 at 3.25 or the daily close at 3.76, current price trades below all averages with focus on higher prices due to oversold yields longer term. The current monthly average at 3.25 is the lowest reported average in five years and the current range lies between 3.25 and highs at 5.82, seen 53 months ago or 4.41 years.
2 Year averages from 1 – 30 years align as 2.99, 3.26, 4.75, 5.71, 6.48 and 349 months or 29.08 years factors to 7.98. The noted point is 13 data points were missing in the RBNZ series from November 2014 – November 2013. Reported averages are close but not accurate. The last traded close price was 3.06 and last monthly average was 3.12. Why the 2 year average is due to its introduction to coincide with NZD free float in March 1985 as opposed to the 1 year average with more data points missing and introduced June 1987.
10 Vs 2 Year Spread. An imperative to understand NZ markets is the 10 – 2 spread. The current price at 0.61 trades between 1 and 2 year averages at 0.46 – 0.88. A break of 0.88 targets the range between the 2 and 5 (57 months) year average from 0.88 – 1.16. The 5 year average is oversold while the 1 and 2 year average is middle range in its price structure. The 1 year targets 0.69, 2 year 0.41 and 5 year 0.72. If a price break lower occurs in the 1 year average then focus falls to 0.22, the last monthly average. Targets then become 0.23, 0.41 and 0.72. What changes is the 1 year target price.
In interest rate terms, no dramatic moves are seen however the bias is higher prices but on a slow and gradual path. When the RBNZ last embarked on its three rate rise cycle, interest rates were literally on the floor. What determines how far and how fast yields and interest rates move is pending economics.
New Zealand’s GDP grew 0.8 in the last 2014 quarter or 3.2 annualized. In terms of annual averages alone, the figure is actually 3.3. Based on annual averages dating to Q1 1990 and rescaled to 1,5 and 10 year averages, the 1 year average is found at 2.51, 5 year at 2.68 and 10 year at 2.57. The targets from 1 – 10 years are 2.84, 4.49 and 4.62. From current 3.3 or 3.2, the 1 year average is overbought yet the current 3.3 projection is above all annualized averages. A drop in GDP is corrective unless 2.51 breaks lower yet the bias is higher.
To offer comparative context and rescaled to the same methodology, AUD annual GDP projections are found at 2.7 with a 1 year average at 2.85, 5 year at 3.00 and 10 year at 3.09. The 1 year average is key for AUD as the targets based on 2.7 and below the 1 year average is 2.24, 2.21 for the 5 year and 1.8 for the 10 year. USD at current 2.4 GDP annualized is above the 1 and 5 year averages at 2.19 and 2.00 yet 2.4 is bumping against the 10 year average at 2.47. Targets are 2.4, 3.6 and 0.8 for the 10 year. Above 2.47, target becomes 4.12.
USD in GDP terms reveals a trend just beginning unless 2.19 breaks lower in which case a Fed Funds rise would become questionable unless a weird quirk is seen in a particular quarter. The UK from 2.8 GDP annualized reveals 1, 5 and 10 year averages at 1.54, 1.88 and 1.95 with targets at 2.32, 3.83 and 3.74. For the UK, 2.8 annualized is the highest level seen in many, many years. Japan is highly questionable as the recently reported GDP 0.6 quarterly or 2.4 annualized sky-rocked above 1,5 and 10 year averages at 1.19, 0.89 and 1.20. The annualized point at 2.4 is the highest level in Japan for many years. The targets from 2.4 are 1.83, 2.88 and 3.25. From 0.6, the 1 year target becomes 0.55. New Zealand GDP is currently routpacing its counterparts.
Annual CPI averages from Q1 2015 to Q1 1990 and again rescaled to 1,5 and 10 year averages reveal the 1 year average at 1.025, 5 year at 2.42 and 2.41 for the 10 year. As an economic release from current 0.1 and down from 0.8, all averages are way oversold therefore targets from 1 – 10 year include 0.60, 1.29 and 1.13. The point at 0.1 is a historic low, never before seen in New Zealand since 1990. CPI Q Vs Q from March 15 – September 1989 and rescaled again reveals the 1 year average at 0.2, the 5 year at 0.59 and 10 year at 0.58. March 2015 reported minus 0.3 and minus 0.2 previous. Only 12 quarters reported negative CPI and 7 of those negative quarters were derived since the 2008 crisis. CPI minus Petrol Q V Q reported 0.3 March 2015 and 0.1 previous. The 1 and 5 year averages rescaled are 0.28 and 0.56. Current 0.3 is above the 1 year but below the 5 year average yet current 0.3 was seen 10 times in the last 13 quarters. Petrol is not the driving force behind CPI.
Tradables vs Non-Tradables
Definition: Goods and Services that enter international trade and satisfy the Law of One Price are defined as a tradable. It is a measure of traded industrial output in terms of Imports and Exports and domestic produced goods. Non-tradables are domestic produced goods based on supply/demand factors but not slated to export such as land, a toaster.
The Law of One Price also defines Purchasing Power Parities to answer the question “does Tradable widget A sell for the same price in Asia as Europe and America?”. The RBNZ mentioned this point in the April statement as they are watching closely the price of Tradables in various markets.
Since exchange rates such as NZD/USD are falling, the RBNZ must take into account future export prices because tradables contribute to GDP yet are calculated in CPI by each economic sector operating in the larger economy. Tradables should remain stable or rising to increase output and revenues in exports, while Non-Tradables should fall, a buy-low sell-high scenario of exported goods. Generally when Non-Tradables exceed Tradables, a weak demand problem exists economically and could easily be cause to lower OCR to again generate GDP growth.
New Zealand’s Non-Tradables prices have been higher than Tradables for the past 6 quarters. Twice in the past 12 quarters have Tradables been higher than Non-Tradables. Since 1990, Tradables were negative 25 quarters while Non-Tradables remained positive, a mixed matched relationship and a persistent conundrum for New Zealand.
Import Vs Export Prices, Current Account
The incessant problem in Tradables is further seen in Export Vs Import prices. Import prices were negative every year for the past 12 years while Export prices were negative in 8 of the last 12 years in terms of annual averages dating to 1990 and 1989. Part of the disjunction may be Export demand related to seasonality of New Zealand’s commodities, such as Milk and / or level of exchange rates.
Academic literature would define this phenomenon as Exchange Rate Pass Through where the exchange rate level is not producing desired results in Import or Export terms. No mystery why the RNBZ recently began to voice concerns in exchange rate levels since Imports and Exports has an equal weight to produced goods as much as repatriations home. Further, New Zealand Current Account as a % of GDP has been negative every year since 1970 except for 1972 and 1973.
New Zealand’s Home Price Index Q V Q at 2.6 is nearly the highest price last seen 6 and 7 quarters ago at 3.0 and 2.9. When last prices of this magnitude were reported was 31 quarters or 7.5 years. Averages from 1, 5 and dating to December 1990 reveal 1.79, 1.63 and 1.44. Not only are prices above all averages but targets reveal the Home Price Index remains high. The targets from 1 – 10 year averages include 2.54, 3.69 and 3.39. An annual view reveals the Home Price Index at 6.3 from March 2015. Contextually, 6.3 is below rescaled averages at 6.8, 6.69 but above 5.93.
Mortgage Interest and 2 Year Fixed Rates
The RBNZ recently introduced Loan restrictions to include 20% – 35% down-payment for home dwellings. As noted above, New Zealand’s Home market is volatile but most volatile in Auckland. Current 6.6 Mortgage interest is at the highest levels, last seen 74 months ago or 6.16 years. With the combination of loan restrictions and a correction in home prices expected, banks are intently competing to lower Mortgage and Fixed Rate interest. The 2 year Fixed Rate is now hovering just above 5.0. The 6.6 point remained the constant monthly average for 8 months. Based on monthly averages, the 1 year average is located at 6.41, 5 year at 6.03, 10 year at 7.45 and 20 year 7.52. The 2 year Fixed rate at 6.0 accompanies the 1 year average at 6.20, 5 year at 6.12, 10 year 7.07 and 20 year 7.21.
Exchange Rate Trade Weight Index
As Tradables are understood as internal demand and productive capacities, the exchange rate is the final arbiter to the export price, price to sell and profit generated. The Trade Weight Index level weighs heavily on every OCR decision because NZD is indexed to the exchange rates of major trade partners as a measure of its goods and services.
Purchasing Power Parities is defined as a current indexed exchange rate price of goods and services to answer which trade partner nations to sell Milk and widgets, where profits generate and which nation to exclude. If NZD/KRW in Korea has an exchange rate disjunction in relation to shipment and Milk profits then possibly Canada and NZD/CAD will purchase Milk since the exchange rate is conducive to shipment and profits.
OCR levels are as much factors as export competitiveness in exchange rate trade as CPI is to internal prices and productive demand. The RBNZ maintains two TWI indices to measure exchange rates, Nominal and Real. Nominal is the daily rate while Real TWI is the monthly average of the Nominal yet both are recorded as monthly averages.
The Nominal 1 to 16.3 year monthly averages are located at 79.04, 74.60, 72.40 and 68.36 with targets from the last 79.17 monthly average at 80.73, 78.56, 77.53 and 76.32. From current 76.05 daily rate, targets for the 1 and 10 year averages drop to 77.34 and rise to 79.53. The 5, 10 and 16.3 averages are all approaching oversold.
Real TWI from 1 – 16.2 year averages are located at 78.99, 75.47, 73.51 and 68.97. From current 77.67, targets are found at 77.07, 78.72, 78.21 and 77.72. The trade and monitor is found at the Nominal Rate. Generally as Purchasing Power Parities rise, the home currency rises as Imports are reduced. Inversely, as the currency price drops, exports increase and Purchasing Power Parities fall.
As Exports to Asia is most vital to New Zealand, 5 currency pairs in the TWI are problems. Based on 1 year views, Correlational problems exist in NZD/CNY, NZD/HKD, NZD/EUR, NZD/PHP and NZD/IDR. NZD/EUR and NZD/IDR lacks a positive correlation to NZD while NZD/CNY, NZD/HKD, NZD/PHP are at Correlational peaks. NZD/KRW is approaching peaks as well.
As the order of the current day is nations to drop exchange rates to lowest levels and lowest common denominator against each other, the future will hold a period when exports from nations will intensively compete with each other. In the end, I don’t see the RBNZ is ready nor should drop OCR.
What that means for NZD/USD is a continuation to sell rallies to next point at 0.6912.