RBNZ Preview: 50bp Hike, NZD to Fall Through 0.60, Value in Receiving NZD 2Y OIS

Summary

• The November Reserve Bank of New Zealand (RBNZ) November forecasts proved too hot for reality. Both inflation and the labour market have disappointed.
• Secondary indicators point to easing pressures, too, while business and consumer surveys record recessionary outlooks.
• We expect the RBNZ will hike the Overnight Cash Rate (OCR) by 50bp to 4.75%.

Market Implications

• There is value in receiving NZD two-year OIS and being short NZD/USD.

Introduction

At the last meeting, the RBNZ hiked the OCR by 75bp to 4.25%, as we had expected. They used the meeting to turn much more hawkish, forecasting a 5.5% peak in the terminal rate (versus the 4.0% before). The decision also contained greater depth on how they are looking at the labour market and relative comfort on the housing market. Since then, data has disappointed. We believe the RBNZ will fall short of their forecasted terminal rate.

Falling Short of Forecast

Inflationary Pressures Better Than First Thought

Since the November meeting, inflation has proven weaker than forecasted (Chart 1). Moreover, our index for New Zealand CPI inflation suggests a downturn sooner than forecasted (Chart 2). This is not to say inflation is no longer a problem. Services inflation remains rampant while core readings remain strong (Charts 3 and 4).

Meanwhile, inflation expectations – which strongly contributed to the hawkish November decision – have, as a worst-case takeaway, moved sideways. Two- and five-year business inflation expectations have touched lower; consumer inflation expectations did likewise (Charts 5 and 6). ANZ/Roy Morgan inflation expectations have turned, too (Chart 7).

Labour Market Tight, but Turning Faster Than Forecasted

The labour force proved weaker than forecasted in the headline. Unemployment was 0.2pp above forecast, and private sector average hourly earnings 1pp were below the forecasted peak (Charts 8 and 9). Our unemployment index has turned negative, indicating a sharper weakening may be forthcoming (Chart 10).

Secondary data points post an equally non-bullish outlook on the labour market. The ANZ business employment outlook is deeply negative (albeit short of 2020 lows), SEEK new job ads have returned to trend, and manufacturing employment remains contractionary (Charts 11, 12 and 13).

While the weaker headline prints help, the RBNZ will turn to their ‘Maximum Sustainable Employment Indicator Suite’. We have recreated it (Table 1). They (loosely) compare figures versus December 2019. The latest figures show just one (underemployment rate) of 16 figures below their December 2019 level, helping confirm the 50bp hike.

Recessionary Outlook on Economy

The ANZ Business Survey adds to the weaker inflationary and labour market data (Table 2). While the headline number has bounced from its all-time weakest reading, the negative pressures remain broad. Notably, investment remains poor, the outlook remains sluggish, and profits are likely to be negative.

Downside for NZD 2Y OIS Yields and NZD/USD

Turning to markets, we see value in receiving NZD 2Y OIS swaps and being short NZD/USD. On the former, NZD two-year OIS swaps have traded 50bps higher from February lows, taking them back to similar levels seen around the hawkish November RBNZ meeting (~5.1%; Chart 14). Going into the November meeting, inflation had (un)comfortably beaten forecasts, inflation expectations had spiked higher, and the labour market remained tight. As the above states, the case has weakened. The risk proves that the global selloff continues, seeing NZD 2Y OIS swaps back to cycle highs of 5.25%. We would class this as a better scope for entry.

Meanwhile, on FX, NZD/USD is 12% off October lows, trading strongest with Kiwi – US yields spreads, and local and China equities. As noted above, we see downside to Kiwi front-end yields while Mustafa sees value in being short the US two-year. It means the spread should widen in favour of USD, with the two-year swap yield spread c.25bps from 2022 lows. Turning to equities, Kiwi equities posted their worst session in eight months following Cyclone Gabrielle while the CSI 300 is yet to return to January highs (4,200; Charts 16 and 17).

Should the RBNZ want to protect its hawkishness, and fail to revise expectations, it could see NZD strength in the short term with markets pricing in 43bps.

Bottom line

The RBNZ made a point of being hawkish in November, revising forecasts, expecting to reach a 5.5% peak OCR. However, data has disappointed since. We believe the RBNZ will have to acknowledge this, and, as a result, there will be further negative pressure on NZD 2Y OIS yields and NZD/USD.

Ben Ford is a Researcher at Macro Hive. Benjamin studied BSc Financial Mathematics at Cardiff University and MSc Finance at Cass Business School, his dissertations were on the tails of GARCH volatility models, and foreign exchange investment strategies during crises, respectively. 

Photo Credit: depositphotos.com

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)