GDP in the December quarter fell 0.1 percent, and has now fallen 0.3 percent from a year ago.
And if the response to the announcement on financial markets is anything to go by – in which the kiwi dollar slid below 60 US cents and the NZX50 enjoyed its best week of the year with a gain of 1.8 percent – investors are betting those cuts may come sooner than expected.
A flurry of dovish messages from the world’s biggest central banks in recent days as they continue to weigh the prospect of multiple interest rate cuts also added more ammunition.
The announcements were music to the ears of global equity markets, further boosting bullish sentiment and underpinning what has already been a stellar performance in the first quarter, though less so for local investors with the NZX50 up just 2.1 percent year-to-date.
Unlike past inflationary struggles, which have come at a heavy cost involving recession and increased joblessness, today’s policymakers are increasingly convinced the holy grail of “immaculate disinflation” – as the Financial Times recently termed the vanquishing of inflation without driving up unemployment – is now seemingly within reach.
A flurry of announcements began on Tuesday with the Bank of Japan ending a decade of ultra-loose monetary policy by calling time on negative interest rates. It was a stunning policy reversal for the central bank that remained the only holdout to continue with negative rates. The move also reinforced a dramatic turnaround in the fortunes of the Japanese economy which has seen its benchmark Nikkei225 share index become the world’s best-performing equity market this year after decades of subpar growth.
The US Federal Reserve followed on Wednesday by holding rates steady at a 23-year high of 5.25 percent to 5.5 percent but confirmed that it expected to make 0.75 percentage points of rate cuts this year, signalling confidence that inflation was finally on the run. The news pushed the benchmark S&P500 index to a new record high of 5261 bringing its year-to-date gain to 10.3 percent.
The Bank of England (BoE) echoed the Fed on Thursday by keeping UK rates at 5.25 percent but also signalled it was edging closer to cutting borrowing costs.
BoE governor Andrew Bailey said things were “moving in the right direction” adding that inflation pressures were now moderating. London stocks followed Wall Street’s trajectory, putting the FTSE 100 also on track for a record high.
However, compared with the US and the UK, the path to rate cuts in Europe is a little less certain.
Although the data for the eurozone tells a similar tale to that of the UK, European Central Bank chief Christine Lagarde said on Wednesday that high wage growth and weak productivity meant services inflation was proving stickier than expected. The ECB would need to continue checking that “incoming data supports our inflation outlook”, she argued.
But perhaps the week’s biggest surprise came from Switzerland’s central bank with an unexpected quarter-point cut in rates to 1.5 percent, making it the first central bank of a major western industrialised country to do so in the era of the post-pandemic inflation surge.
By contrast, Turkey, which is still scrambling to halt runaway inflation, surprised in the other direction with a 5 percentage point rise to 50 percent.
Stage set for RBNZ’s next monetary policy review
With just 16 days to go until the RBNZ’s next monetary policy review, investors are already betting that it too will be forced to consider cutting interest rates before the end of the year after sluggish economic growth and confirmation that the NZ economy has dipped back into recession.
This week’s latest ANZ Business Outlook survey on Wednesday and ANZ – Roy Morgan Consumer Confidence on Thursday are likely to reveal subdued results.
Though last Thursday’s GDP numbers for the December quarter revealed there were no large negative surprises across the main parts of the domestic economy, apart from a run-down in inventory levels, the data confirmed there was ongoing softness in household spending and business investment.
The sharp reduction in inventories for the second time in three quarters, which recorded a -2.8 percent contribution to quarterly activity, came as the distribution sector continues to reverse the increased stock levels that were held during the pandemic.
Additionally, a 2.9 percent reduction in import volumes, the fourth consecutive quarterly decline, reflects the run-down in stocks and continued weak demand from households and businesses.
Discretionary spending also took a big hit with alcohol and tobacco (year-end growth of -5.0 percent), clothing and footwear (-4.8 percent), communication (-2.6 percent), and restaurants and hotels (-8.8 percent) all falling sharply. Significantly, all these declines are the biggest since at least 1992 (excluding Covid lockdowns), and the 3.4 percent year-end decline in recreation and culture spending is the largest since 2009.
But it was the 6.7 percent year-end decline for investment spending on plant, machinery, and equipment, the largest since 2010, that caught the eye of analysts suggesting businesses are joining households in hunkering down and cutting capital expenditure to the bone.
The construction sector also remains under pressure with the downturn in residential building clearly evident after the quarterly level of activity slipping to its lowest level since 2018, and the 4.3 percent year-end decline in residential construction is the biggest since 2011 (excluding lockdowns).
But there was one bright spot among the otherwise downbeat GDP data. Export volumes rebounded 3.2 percent from the previous quarter’s decline, to a new post-Covid high. Meat products and chemical products both looked particularly strong, though there was continued weakness in agriculture and fishing primary products.
As Infometrics economist Gareth Kiernan noted in his commentary on the latest GDP data, the numbers continue to show an economy struggling under the pressure of elevated interest rates.
“[Despite] annual population growth currently running at 2.8 percent, New Zealand’s GDP per capita has shrunk 2.1 percent over the last year. This result is now closing in on the 2.9 percent per-capita contraction recorded in 2008/09 following the Global Financial Crisis.”
The extent of the squeeze on households is even more acute, with per-capita consumption spending down 2.5 percent over the last year.
Though Kiernan points out that so far businesses have reacted less sharply, this can partly be attributed to the fact their output had previously been constrained by labour shortages. However, he says further declines in investment spending are possible as labour shortages ease and firms react to weaker demand levels.
Tight monetary and fiscal policy are constraining domestic growth, and sluggish international demand conditions, particularly in China, he says are a factor behind export volumes still being 4.2 percent below their pre-Covid level. A strong and sustained recovery in New Zealand’s growth is unlikely while the global economy remains weak.
BNZ chief economist Mike Jones said the NZ economy continued to bump along the bottom.
“It has struggled to grow for more than a year now, real per capita incomes have dropped sharply, and the unemployment rate is rising. An undershoot relative to RBNZ expectations can only encourage the market to bring forward the timing of expected OCR reductions.”
At the margin, he said this view was understandable, but shouldn’t be considered conclusive.
“At face value, the latest GDP figures increase the chance that the RBNZ brings forward the timing of its projected first reduction in the OCR from H1 2025 into this year. But we wouldn’t overstate the case. After all, it is only a 0.1 percent miss relative to the RBNZ’s forecast of no change to December quarter GDP.”
Roll on April 10 when the Reserve Bank will release its latest Monetary Policy Review, as the drumbeat for interest rate cuts continues to increase in volume.
US commercial real estate could spell trouble in the future
Bloomberg reports a new flashing red light investors should pay attention to involving US commercial real estate that has ominous similarities to a major cause of the global financial crisis in 2008/09.
An obscure investment product used to finance risky projects is facing unprecedented stress as borrowers struggle to repay loans tied to commercial property ventures.
Known as Commercial Real Estate Collateralised Loan Obligations, or CRE-CLOs as they’re known (remember their equivalents from the GFC involving US residential housing loans), they bundle debt that would usually be seen as too speculative for conventional mortgage-backed securities. In just the last seven months, the share of troubled assets held by these niche products has surged fourfold – rising by one measure to more than 7.4 percent of total CRE loans.
For the hardest hit, delinquency rates are in the double digits leaving major players in the US$80 billion market rushing to rework loans while short sellers ramp up their attacks on publicly traded issuers.
The pain is part of a broader, post-pandemic shakeout in the $20 trillion US commercial real estate market, which almost brought down New York Community Bancorp in recent weeks and has elicited warnings from US Treasury Secretary Janet Yellen and Federal Reserve Chair Jerome Powell who have expressed concern at the elevated level of distressed debt in the sector.
Though not on the scale of the US housing market, industry observers say few products are more exposed than CRE-CLOs which will be the first shoe to drop in terms of defaults in the CRE debt markets, analysts point out.
“The loans inside CRE-CLOs tend to be for transitional properties, so the borrowers are counting on reselling them before the loan matures. But today many borrowers can’t sell properties for anywhere near where they bought them,” one analyst pointed out in their commentary.
The news is a further reminder to investors that lurking just below the all-pervasive bullish sentiment lie the elements that will eventually reveal themselves as the basis for the next financial crisis.
Coming up this week:
Monday
· Business Operations Survey (2023) – Stats NZ
Tuesday
· New residential mortgage lending data (Feb) – RBNZ
· Regional GDP (Y/E Mar ’23) – Stats NZ
Wednesday
· ANZ Business Outlook survey
· NZ King Salmon – full year result
Thursday
· ANZ-Roy Morgan Consumer Confidence survey
· Employment indicators (Feb) – Stats NZ
· Hallenstein Glassons – half year result
