Monday, February 28, 2011

Old Rates for New Zealand

It's month end and there are going to be all sorts of associated wobbles but, overall, stresses are lifting and there appears to be a reversal of Middle East inspired moves, perhaps as punters look to strap risk on ahead of expected equity inflows for the new month. It would appear that 80% of Libyan oil fields are in "rebel" hands and that they are starting to export from Tobruk again and we are pretty sure that Saudi could replace any Libyan shortfalls. So really Tripoli could look like Baghdad in 2004 and it really shouldn't do anything to oil. But a quick question - when does the "rebel" title get exchanged for "authorities"? Because "rebel" always seems to imply minority and it appears that the rebels are now the authorities of most of the country.

So, metals are moving up, equities had a good close in NY followed by a reasonable response in Asia and it's only Europe that has had a shot at trading the down side. In fact equities have done really well considering how much bad news has been thrown at them. Just like AUD/USD, which despite all sorts of normally negative muck is trading only just below its highs. We have also been pondering the price action in Ags, with Cotton tracing out the sort of chart that is gappier than Mike Tyson's teeth at A GAP conference in Bank Tube station, with shortages by textile manufactures causing the latest squeeze. TMM are hoping that fresh supply relieves any pressures to use recycled cotton before we are forced to wear belly-button-lint blue/grey shirts.

But today we would like to have a look in more detail at what is going on in NZ where the debate is raging about the impact of the Christchurch Earthquake...

Readers will recall that TMM were strongly of the view that the Queensland floods in Australia were, if anything, net growth positive due to the fact that infrastructure rebuilds usually entail the replacement of older plant machinery etc with more modern and more productive versions. Furthermore, they represented an inflationary supply shock to an economy already growing above trend, with a likely looser fiscal stance adding to underlying inflationary pressure. Although, for childish political reasons, the Australian government decided to introduce a tax to help pay for the cost of rebuild, along with redistributing current expenditures, it remains the case that a fiscal policy response to natural disasters is the appropriate one given the ability for such policy to be (a) targeted centrally and more directly, and (b) more immediate in terms of action than monetary policy which, beyond an immediate impact upon confidence (in demonstrating that policymakers are on the ball), works with a longer lag via credit creation and is more dependent upon individual businesses exhibiting demand for loans.

But what about if the economy is *not* already growing above trend? It's certainly possible to argue that a second earthquake in 5 months could be a body blow to the economy via the consumer confidence channel. To date, the recovery in New Zealand has been somewhat, err, tepid, joining the UK in putting in a negative quarter of GDP. Perhaps, then, punters are correct in pricing in 32bps of easing over the next two RBNZ meetings, with 30bps for March alone? It's hard not to draw parallels with the Fed's rate cuts in the aftermath of 9/11, rather than with their hikes in the aftermath of Hurricane Katrina. But even before September 2001, the front-end had priced out a great deal of tightening and was beginning to price in an extension of the Fed's cutting cycle as it was clear that the economy was falling into recession, so TMM is not sure that is necessarily the perfect analogy.

But what is clear is that the RBNZ decision is very much a function of the economy's underlying state. Today's Business Confidence survey provides some grounds for optimism that after the recent "soft patch" that activity was beginning to pick up. The below chart shows the 3month moving average of the NBNZ Activity Outlook (white line) vs. the 4-quarter lagged YoY GDP data (orange line), and suggests that prior to the earthquake that GDP was likely to accelerate to around 4% or even higher over the coming months. Similarly, the surge in Milk prices and Ags in general underline the significant strength in the Agriculture sector on the back of external demand.

To date, one of the weaker areas of the economy has been consumption - primarily, TMM presume, due to September's earthquake. TMM's model of Retail Sales based upon Consumer Confidence, Consumer Credit growth, Wage growth and the RBNZ's survey of expected wages 1yr ahead (see chart below - orange line; actual Retail Sales - white line) suggests that sales should have been running at around 3.75-4% YoY. The divergence in Q4 of last year is presumably a combination of the effects of last September's earthquake and general statistical noise. Certainly, one would expect consumer confidence to fall and drag the model projection lower, but it's not obvious that it would plumb the lows at the high of the financial crisis. Even if it did, the other inputs to the model aren't flashing warning signals which would lead TMM to worry about a complete collapse in consumption...

...And TMM's Inflation-Expectations augmented Taylor Rule (see chart below, white line; RBNZ cash rate - orange line) for the RBNZ seems to imply that policy is already exceptionally loose. While it's certainly possible to argue that the RBNZ could hold off tightening in the face of the disaster, it's not necessarily obvious that easing would be a particularly sensible thing to do.

However, TMM recognise that the RBNZ have been walked into a corner given that the market has priced in such a great deal of easing, with the press and local economists calling for as much as a 50bps cut. Given that central banks generally do not like to surprise markets to the downside, especially during crises, TMM are forced to conclude that even though the underlying economy actually looks as though it was in the process of reaccelerating, that the most likely outcome in March is a 25bps cut. However, with a good deal more priced in (see chart below: OIS forwards - red line; 3m Bank Bill forwards - purple line; spot OIS - blue line), for the brave, a pay position in the March RBNZ OIS or a long NZD position might be worth a punt. TMM are too chicken to do the former, and instead elect to sell their old nemesis AUDNZD.


Anonymous said...

weird ... 90% of your analysis is on why NZD rates too low yet you choose to sell AUD/NZD ... sure AUD at upper end of range but so what? if this risk off episode dissipates we could have another leg up in metals etc. just sell a smaller amount of NZD bills or do some calendars ... keep it simple.

cpmppi said...


Yeah, risk reward not necessarily there given they could do 50bps. Perhaps a better implementation is just long NZD outright if you think we trade back to the highs in risk. If they cut 50bps, you'd probably get a chance to stop out at a percent down or thereabouts whereas the rates market will just move digitally to the "right" price with essentially nothing trading (not that much ever trades in Kiwi bills anyway...!).

Or perhaps a mixture of all of the above?

Anonymous said...

through digital events, stops in FX possible with some slippage ... but bills, forgetaboutit.

so i guess choice based on expected holding period, conviction and expectations though i wouldn't have both on simultaneously unless you were doing the rates differential vs fx trade.

Leftback said...

Oddly enough I was thinking about this first thing in the morning as we own some NZT. Reading between the lines things seem fairly despondent there, so a 50 bps cut might not be off the mark, they will want to get re-investment going promptly, huge amounts of work ahead, and the rugby World Cup potentially bringing a lot of tourists/money to NZ in September. Maybe wait until they execute before getting long NZD?

zen said...

I've long been in the camp that the the floods are GDP -ve (I realise this is a small and lonely camp!!!)
But having had two reasons I now have a third:
(1) building activity in Oz was already near capacity so the blood rebuild will simply redistribute these resources rather than increase activity
2) The impact to commodity exports will be significant... even if prices are higher
... and now the new reason
3) popular press reports only 10% of insurance claims have been paid and there is a very big gray area on what caused this flood and who is covered. Sunny day flooding, dam mismanagement. If it turns out that most people are not covered this will be very GDP negative as people reallocate consumption savings etc!!!

ShortBus said...

Zen: The area of Queensland which was actually affected was small relative to the whole country. Much of the people living in Brisbane or surrounding areas were simply inconvenienced by the floods, and not bothered by it.

So your argument that consumers will cut back after not getting payouts from insurance companies is not very valid, as there might only be 1000 people out of the 20 million inhabitants that will need to cut back. This can hardly be considered significant in the scheme of things with respect to country GDP.

90% of a very small number relatively is still a very small number.

Anonymous said...

Short AUD doesn't work

zen said...

Short Bus, I live in Australia and you're incorrect that it was a small area confines to Queensland. Significant flooding also occurred in norther NSW and Victoria. That said I accept it is relatively small percentage of the population... a quick google says 47k claims amounting to 2bio AUD.
However, my argument is that the floods are GDP -ve and my reasoning to the insurance claims is only to counter those who claim that the payouts will make it GDP +ve. The disruption to mining is the biggest factor in my opinion.

Anon, "short AUD doesn't work" that is correct but the more people convinced by this the more it opens up the down side..... when that will be I don't know!!