With the Reserve Bank of New Zealand (RBNZ) lowering the Official Cash Rate (OCR), Mark Lister from Craigs Investment Partners highlight five key points investors based in NZ and abroad should know about. As partners of Kea, Craigs Investment Partners will be providing ongoing market commentary to help you make informed decisions on your New Zealand investments.
This week the RBNZ chose to lower the OCR by 25 basis points to 3.25%. While there was broad agreement that an OCR cut was inevitable at some point, markets were divided over whether this would take place this week. Consequently, there was a strong reaction from financial markets with the NZ dollar falling sharply and market interest rates also declining. We believe this was a sensible move by the RBNZ, and highlight five key points for investors to be aware of in light of this decision.
1: At least one more OCR cut to come, in either July or September. The RBNZ’s projections imply one further OCR cut over the coming months, with the timing dependent on the flow of economic data (most notably dairy prices and inflation). This would take the OCR to 3.00%, and the balance of risks identified by the RBNZ suggests some openness to additional easing beyond that, if necessary. Markets are pricing in a 50% chance of this additional cut taking place in July, with this follow-up move now fully priced in for September. In addition, markets are pricing in a reasonable chance of a third cut on top of that later in the year.
2: Lower dairy prices look to be the key driver behind the change of stance. The last time we saw the RBNZ cut the OCR was in 2011, which was in response to the Canterbury earthquake. This time, it appears to be falling dairy prices that are of most concern to the RBNZ. In the press conference, RBNZ Governor Graeme Wheeler noted the worsening terms of trade (due to a combination of rebounding oil prices and falling dairy prices) a number of times. The $4.40 payout for the current season will be the lowest level since 2006/07 and well below the ten-year average of $5.85. More importantly, the opening forecast for next season of $5.25 doesn’t suggest much of a rebound is forthcoming. However, it should be noted that the opening forecast for the last two years has been $7.00. Last year this was reduced five times and ended up at $4.40, while the previous year it increased to a record $8.40.
3: With some downside to the outlook, fixed interest remains attractive in real terms. While borrowers will cheer today’s decision and look forward to further OCR cuts, savers and fixed interest investors will be less enthusiastic. This is a reminder that while fixed interest yields remain lower than many would like, they could easily go lower. We continue to believe that fixed interest is an attractive hedge against adverse global events. We note that while nominal yields are unappealing, with inflation at very low levels the “real” interest rate remains acceptable.
4: Lower interest rates are likely to provide ongoing support for equities. Given the attractive yields on offer, local equities have performed very well in recent years in the face of lower interest rates. While some share prices have risen strongly and appear fully valued, the demand for yield could keep the market supported for some time. With term deposits offering less than 4.0% per annum, the average NZX50 gross dividend of 6.0% remains attractive. Some sectors are offering substantially more, such as the electricity sector, which is trading on an average gross yield of 8.1% following recent weakness.
5: Further weakness in the NZ dollar is likely. The NZ dollar has been under pressure for much of this year. Most notably it has fallen almost 10% against the US dollar to just over US$0.70, levels last seen in mid-2010. The currency is down 9.3% against the British pound, 5.1% against the Australia dollar and 3.4% against the Euro. The RBNZ reiterated its view that the NZ dollar is still too high, and we would expect further OCR cuts to see the currency drift lower, particularly against the US dollar given that a Fed rate hike is likely at some point. This currency weakness will boost the export sector and soften the impact of falling global dairy prices. However, it could contribute to tradable inflation creeping higher, as petrol prices and goods become more expensive. We believe investors should continue to focus on opportunities within global equities, as well as good quality local companies with an export focus.
Mark Lister is Head of Private Wealth Research at Craigs Investment Partners. This is class advice only, for personalised investment advice please contact an Investment Adviser or phone 0800 272 442 or +64 7 577 6049.