Since March of last year, global share markets have had their most volatile period in 270 years. The recent Delta outbreak in New Zealand has seen the Reserve Bank of New Zealand pause on their expected interest rates increases. Confirmation that we have contained Delta will likely see interest rates increase towards the end of the year.
Prior to the outbreak, markets were starting to price in an increase in inflation in New Zealand. Globally the inflation trend is well established and will likely spike as we head towards Christmas. Typically, an increase in inflation results in higher interest rates from Central Banks.
There has been a slight change in the way in which the Federal Reserve of the United States views inflation. In short, they are likely to run their economy “Hot”, which means with sustained above average inflation. The reason for this is they need a new way to remove the quantitative easing from their economy. Post the GFC, rates were raised too soon and the reliance on money printing remained. The last time the US economy sustained inflation at levels expected was during the 1980’s.
House price inflation in New Zealand is at its highest in 20 years and is at an unsustainable level. This has in turn forced the Government & Reserve Bank to clamp down on investors and signal higher interest rates towards the end this year. Earlier this year the Government highlighted changes for property investors which will encourage funds towards the share market.
The new delta, delta + and lambda variants of Covid19 are also causing concern for investors as is changing rhetoric and actions by an increasingly confrontational China. These developments are being closely watched.
The recent reporting season was robust, showing the strength of the New Zealand economy. Although, as we have seen, these things can change quickly with another outbreak.
The Governments books are in reasonable order and the Reserve Bank still has plenty of fire power to fund another nationwide level four lockdown for a short period, but not indefinitely.
Next year the Government will have to make a call as to what is the optimal coverage for vaccination. Some are suggesting around the 75-80% level is all we can hope for. From there, the virus will be able to roam the country as will the rest of us.
Globally, China economy is spluttering back to life. However, logistical issues and Government crackdowns on certain sectors are hampering growth.
The United States and Europe are opening up as virus numbers surge. Both of these economies are likely to live with higher than typical inflation for some time. We are of the view that the Reserve Bank of New Zealand will not tolerate this high level of inflation and will have materially higher interest rates in the face of such action. Higher relative interest rates increases the demand for the NZD, increasing the exchange rate, helping importers and hurting exporters.
Overall, interest rate increases in New Zealand will need to be balanced against a growing economy and fears of sparking a housing market correction. Stocks that have low growth and low relative yields will be repriced to offset higher rates.