The Fed can taper without tantrum
- As the US economy continues to improve, the US Federal Reserve (Fed) seems close to reducing its pace of bond purchases as part of its quantitative easing (QE) programme.
- Different to the “taper tantrum” of 2013, however, a reduction in purchases is widely expected and is not being associated with imminent interest rate hikes.
- US Treasury bond returns tend to be mixed prior to interest rate hikes but US equity markets generally fare much better.
- That’s not to say it will necessarily be smooth sailing for financial markets. Risks exist in many directions, but a well broadcast tapering may not be the largest concern.
The RBNZ “read the room” with a hawkish hold
- The RBNZ left the OCR unchanged yesterday given heightened health-related uncertainty.
- But with the central bank’s inflation and employment objectives met, the Monetary Policy Committee has a strong desire to reduce stimulus once this uncertainty passes.
- We agree that interest rates eventually need to be a lot higher, but health outcomes will determine when the tightening cycle begins. In fixed income portfolios we are positioned for the OCR to remain on hold while the COVID-19 delta variant outbreak unfolds, but for longer term yields to rise and inflation pressures to persist.
Are retail interest rates about to rise?
- Despite substantial increases in wholesale interest rates over the past 6 months, retail rates have mostly declined as the Reserve Bank of New Zealand has kept the Official Cash Rate unchanged and offered cheap bank funding through its Funding for Lending Programme.
- The Reserve Bank of New Zealand is now more confident in the economic outlook and forecasts a larger amount of interest rate hikes than markets currently expect, beginning in Q3 next year.
- As financial markets price the prospect of earlier and more rate hikes, increasing banks’ wholesale funding costs, retail interest rates are likely to rise, starting with 2-year and longer mortgage rates over coming months, while meaningful increases in term deposit rates may happen later and be more gradual.
RBNZ to drive retail rates lower
- The RBNZ has confirmed that cheaper bank funding will be here in time for Christmas via its Funding for Lending Programme (FLP).
- This will provide fresh impetus for banks to lower lending and deposit rates.
- Lower mortgage rates will likely boost an already-booming housing market. Lower term deposit rates may encourage consumer spending and a hunt for yield.
The Outlook for Monetary Policy: Video
Harbour Asset Management's Head of Fixed Income, Mark Brown, discusses the stance of the Reserve Bank of New Zealand (RBNZ) ahead of tomorrow's Monetary Policy Statement.
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Economic strength to challenge the RBNZ’s dovish stance
- Market expectations of additional Reserve Bank of New Zealand (RBNZ) stimulus, for instance moving to a negative Official Cash Rate (OCR), have been tied to continued cautious communication from the central bank. Interest rate markets today price an OCR of -0.25% in one year’s time.
- The economy, however, is in much better shape than the RBNZ expected, which presents a challenge to its uber-dovish stance and the prospect of a negative OCR next year.
- In our view, the likely launch of a Funding for Lending Programme (FLP) as part of its 11 November Monetary Policy Statement (MPS) further reduces the need for additional stimulus.
- We see the distribution of future interest rate outcomes skewed higher.
Negative cash rates – The afterburner for asset prices
- The RBNZ’s stated preference for a negative OCR, should further stimulus be required, has encouraged the New Zealand market to expect negative wholesale cash interest rates next year
- This forward guidance on the potential for negative rates has led to large declines in retail interest rates and is having a powerful and positive impact on all asset prices
- This week a New Zealand government bond closed with a negative yield for the first time
Negative rates – An option for the RBNZ, but not its preference
Key Points
- The RBNZ continues to entertain the idea of a negative Official Cash Rate (OCR) to provide additional economic stimulus
- There is global precedent but the associated lower policy efficacy and financial stability risks cause much debate
- A negative OCR cannot be ruled out and keeping the option open is likely helping to anchor short-term interest rates and the NZD
- The RBNZ’s revealed preference for QE, however, is clear and an expanded Large Scale Asset Purchase (LSAP) programme remains most likely if further stimulus is needed
Large Fiscal Spending Promises
Key Points
- Budget 2020 revealed larger-than-expected potential spending in response to COVID-19.
- However, detail was lacking on many spending priorities.
- The accompanying larger bond issuance programme may prove difficult for the market to digest, placing upward pressure on government bond yields.
Will RBNZ QE help bridge the gap and how does it work?
What is the Reserve Bank of New Zealand’s (RBNZ’s) Quantitative Easing (QE) programme?After cutting the Official Cash Rate (OCR) by 75bp to 0.25% on March 16th, the RBNZ launched its Large Scale Asset Purchase (LSAP), or QE programme, just one week later. LSAP has a target to buy $30bn of government bonds over the next year; equivalent to 10% of Gross Domestic Product (GDP) and, at the time, almost 50% of outstanding bonds ma...
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