RBNZ pivots to potential lower interest rates

You're listening to the Weekend Collective podcast from News Talks AB.

Right now, it is time for smart money and we want your calls on eight hundred and eighty ten eighty text nine two. And our guest is director and fixed income and currency strategist from Harbor Asset Management and his name is Hamish Pepper. Good Hamish again, good.

Eton, I'm good, thank you?

Are you all right? All right? Thanks? So are you coming to us from Wellington?

I am? I am.

I'm looking out from our office onto the harbor and watching the sunset.

Not too bad sunset already, Oh my goodness, I've just looked out. Yes, well, at least you can say it's but gray here.

So actually gray, I don't know. I was trying to turn into a theme with sunsets and things. But the suns here we go. I've got it, I've got it.

The sun may be setting on the reserve banks. Harsh rhetoric when it comes to what's happening with the cash rate.

Yes, indeed, yes, finally.

Finally I like that. That's not a bad metaphor. I'm going to go with that.

But anyway, so, why has it okay? Why is that statement true?

Well, I think we are really seeing the economy hurt now, and of course that is what they want, because that's the way in which inflation comes back to a lower and stable level.

They want two percent.

They definitely don't want the numbers that we were seeing a year or so ago, and with that they can take the foot off the throat, so to speak, of the economy and lower interest rates and let us all breathe again. Really, they're not quite there yet, but we think they are getting very very close to starting to reduce interest rates.

Would you mean they're not quite there yet? What's not quite there? You mean the Reserve Bank aren't there? Because I think most of us are there.

Well, yes, indeed, and many of us probably been there for months now, looking out the window and hearing stories, seeing data which suggests that, you know, those high interest rates have been very very effective in sort of hurting the economy and taking inflation pressure.

Out of it. Why are they are so slow, so to speak?

I think there's still a residual concern that they might see inflation rear its head again. Inflation inflation expectations what people think about in terms of what prices will do.

So they I think are.

Trying to balance the observed impact of policy, which is strong. You know, we're seeing that with the fact that inflation is not quite back to two percent, and therefore there's still a risk that perhaps if rate cuts come too soon, people then think, oh well, perhaps that might mean that inflation can pick up again, and therefore, you know, the job's not done.

Can you can you give.

Us a description of what of what that what's the inflation rating is now three point three percent I think, isn't it?

And how significant to drop is it?

And what it means in real terms that we can understand in terms of tradable and non tradable inflation all that.

Yeah, I mean, I think we've probably talked a lot about that tradeable part of inflation of prices that we're seeing in the economy having normalized. We talked about supply chains which were heavily disrupted during that COVID time, you know, basically goods not being able to flow through the world like they normally do, and with that cause the prices of those goods to increase. A lot that's now all come out of the system. You've actually got you know,

Market in terms of wage growth.

And that bit is still running quite high on a quarterly basis. That came in almost one percent on the quarter, and it's above five percent annually.

And so that is the bit that's the niggli.

Little bit here which is probably driving that just hesitation or residual concern that the rbnz'd have about taking rates lower too soon or too quickly.

Yeah, so one of the things I saw on well, on Twitter, actually there was a couple of bits to camera from Nikola Willison, also Christopher Luckson saying, look, we're getting on top of inflation. I just had it without I mean, we can get political if you like. Who's responsible because that looks like the government taking credit for the drop in inflation. Who actually can take the credit for inflation coming down?

I mean, I think it's largely the central bank, the zero Bank in New Zealand deserve the credit for inflation falling. Of course, you know the global dynamic of supply chains normalizing. Well, you know that was about the vaccines and you know the world being able to operate again, but that's sort

At at the bottom.

But ultimately that you know, once they got going, they did move in quite big increments. We got to five and a half percent quite quickly and have been there now for some time. You know, those are high intra shrates and they are having a large impact and will be the main driver that takes out inflation back to two per I.

Guess I was asking how much credit the government can take because the reason that Adrian or the Reserve Bank had to sort of well, actually actually maybe he was to blame in the first place. I'm just trying to remember, because there was a lot of government expenditure, of course, which this current government has criticized, which was part of the picture, I guess. But of course the Reserve Bank, who was it that kept cash.

So cheap for so long?

Yeah, I mean, and I think that they admit that that, you know, like I said there that with hindsight, policy was too loose for too long in the Central Bank, they recognized that, I think sooner than perhaps government did, because on the government side, we kept in place quite stimulatory policy things things like wage subsidies, for example, but just generally spending was high through a period where the economy was actually clearly recovering, so there wasn't the need

Government is okay.

So up, I'm an editor to ask the question again now that I've got it clear in my mind. So if the government stimulatory sort of approached, the economy went on too long, along with the cheap cash from the Reserve Bank, and.

So they played a part in us.

Needing to get on top of it, how much credit can actually the government. I'm not doing this to be mischievous, by the way. I'm just quite curious because I was amused when I saw Nikola Willis and Christopher Luxon's video and I thought to myself, I'm not sure how much.

Of this is on you? So how much can they take credit for I.

Don't think much at all. And I think also that you know, really, if you think of government, regardless of the political party, and just think of the role that government played through that time, then you know that they were a key driver of the inflation that then the central Bank had to respond to and is still still doing that.

It's quite fascinating, isn't it.

I just guess in the end politics, if something's going well and you are in government, take credit for it as quick as you can. I mean, then maybe they'll say that. I don't know what arguments could they mount for that. Again, I'm probably pushing the point, but it's just fun to get my own head around it, because I guess they would say, we've set the tone around expenditure which has helped get on top of inflation, and Adrian or subtly has has followed the signals that we've sent out there.

Is that an argument they could make?

Yeah, I mean I think they could.

You know, it's I find it hard to kind of fully buy into it. But the argument that they could put forward is, hey, look, we've got a path now back towards fiscal balance and indeed fiscal surpluses. We are doing that through you know, a reduction and spending over that sort of four or five five year period. But at the same time they're also introducing tax cuts which come live the end of the month, and you know, that's something which ultimately slows your ability to balance.

And keep it under control.

So actually, why you mentioned that, I mean, how stimulatory

Yeah, I think.

I think in a weird way, it has almost by accident, come at a time where the economy really needs it, so it is actually acting in that way that you would expect fiscal policy to work. You know that when there is a downturn in the economy, then you know the government can step in and soften the blow.

So it's turned out that way.

But I don't think anybody thought, including Treasury, that the economy would be as weak as it is now and then likely to be weak over the coming year. So I think it has been fortunate in a way that these are coming along to provide a bit of a cushion.

So well, you I think we've put the politics side to bed a little bit. But it's just I guess that's the amusing side of things, seeing people take credit for different things. I guess at the heart of it is, I've always I've been developing more and more this suspicion that you forget tax cuts and all that the person who has the most control over the welfare of New Zealanders is the guy who controls the cash rate. And

It's a blunt tool, you know.

You'll often hear Adrian talk about it in that way and many central bank governors. But it's very powerful because of how broadly the economy is affected.

And of course we've talked before.

About those that have debt and are impacted by the interest rates that they have to pay on that. But of course there's the other side of it as well, to which is those that are savers or have the ability to save, they will respond to those higher interest rates as well, and they'll be incentivized to save today and spend tomorrow, and that's something which is a driver of the economic weakness we're seeing, as well as those that are struggling to service debt.

Well, let's get onto this the Reserve Bank and that pivot of theirs.

Were you surprise, how would you describe the way that they've shifted their rhetoric?

It was, It was a big surprise.

I think that the timing mainly, I think our view had been that they were on a path at at some point they would recognize just how weak things were out there. But the timing of this was unusual for a couple of reasons. That the meeting prior had been one which we describe is very hawkish. That's one where the rhetoric around sort of inflation risks was prominent. You know, they'd even contemplated hiking interest rates at that may monetary poz.

Nobody bought that one though, you know.

Well, you know they didn't. They didn't, but then they worried. You know, the fact that that was stated in the meeting minutes. It's no accident that those things end up there. So there's a message that they want to want to send. But so we'd all been conditioned to this sort of strangely hawkish sort of central bank and then all of a sudden in this latest meeting, huge change in tone. You know, no way was there any consideration of hikes.

This was one of those interm ones.

Yet they still had this this quite quite significant change in tone. And the final thing was that the chief economist was was actually on holiday. Paul Conway was not there for the.

Meetings, so.

All in all, and what does that mean?

I just think he needed a break, and good good.

I wondered if there was some significance someone's not here, what does it tell us? I mean, that's fascinating see that because you mentioned it, and I was just wondering if it's something you go, oh, he's not here, what's it mean.

Yeah, no, I just think for many they would have gone into that meeting and the lead up and thought, this is not going to be one where we see a big change in communication and tone. They'll they'll largely repeat what they said in May. But instead, I think because of just how quickly the economy is deteriorating, they did feel the need to shift to a more balanced

Well that was unreasonable.

Well that was my next question, because.

What is what's the next event where they could credibly make an announcement about a change in the in the interest rate.

Yeah, they could do it on the on the fifteenth of August.

I think it is roughly they could. They could do it at that meeting.

In between times, they will get some labor market data for the second quarter, which is likely to be really quite poor, and they have a view that the unemployment rate will pick up from the current four point three percent to four point six I mean, it could well be something more like five percent.

And I think in that case, that really does.

I think give them probably enough to seriously contemplate a rate cut in August that there's not a lot left. If you believe that, then this will flow into wages.

It usually does.

Ride a higher unemployment rate lowers the rate of wage inflation. Then on a forward looking basis, you could say with some confidence, you're on your way back to two percent.

Yeah, wow, okay, look hey that's inflation, by the way, not the cash rate. Somebody will go, what hey, look, we'll come back in just a moment. With the Hamish Pepper, he's director and fixed income and currency strategist that have asset management and the fascining come just around the whole rhetoric of the reserve bank and what they're going to do, as Hamish mentioned, could be the middle of August, their next opportunity to put it down, what's your money on?

Because you know what you can better as.

Much as you like about you know, are we going to about government policy and all sorts of things, but another reserve bank are the ones who control so much of our of our well being and it if you've got a mortgage or you're a renter, so what's your bet? Are they going to drop the are they going to drop the rate sooner?

Rather than later.

And it's certainly relevant if you're looking at refixing your mortgage asking for a friend, no personal and because literally i am about to refix my mortgage, so I've got to think about that. I've made up my mind. Don't worry, but you tell me what your work, what your guess is, Oh, eight hundred and eighty ten eighty text nine two nine two, and you can email. I don't worry about emails, calls and texts. Okay, back in the mine, Welcome back to

It's almost like it's almost like.

An active theater, isn't it the Reserve Bank that for such a dry institution, they're quite theatrical at times, aren't they? Because there's always something to read into the nuance, isn't there?

Hamish?

Yeah, I mean there is the I mean, I think one of the things that's been fantastic recently is the frequency with which they are speaking to the public and to you know, financial markets. You know, Paul Conway, the Chief Economist, recently had a speech where he had that on the basis of four pieces of research that have been produced, and you know.

This is just it's great.

Yes, it does give us the theater and then you know we're trying to you know, read the tea leaves and pick apart every every sentence. But you know, it's a great thing for all of us to have a central bank that's working like that, that's doing research that relates to this economy and then they're speaking about it and providing you know, a channel through which we can ask about it and learn about it.

Yeah, I think that's great.

Ye is there? Look, it's just reckons, isn't it.

But do you think there's a little bit of anxiety at the Reserve Bank given that they made that pivot that was unexpected? Do you think there's a little bit of nervousness amongst in their ranks that maybe they've gone a bit too hard too long?

I think so.

Look, I think they will get no credit whatsoever for taking inflation below two percent, you know, two percents of the target. And don't get me wrong, you know we're not there yet, but we are getting close. And monetary policy operates with long and variable lags. You know, it can be up to two years before you get the full impact of where policy settings are today. So yes,

I think that's that's starting to emerge.

I would argue that there have been a lot of people commentators who have argued that for a while, and that seems the last people to realize that was a reserve bank is that harsh.

I think there is always going to be. And financial markets are the same. You know that that cohort that are kind of trying to get ahead of things, you know, and caught in calling for in this case interest rates to fall prior to you know, to them actually doing so.

But I think you're right. I think overall the.

RBNZ have found themselves, particularly recently, a little isolated in their view of of of how things are going to play out. I mean, just for example, the last set of forecasts we had from them, it didn't have the cash rate falling until the second half of next year, and you know, thinking about that today, it's that's just

Yeah, and their options are to drop it by what At the moment, it's five point five, isn't it that they might They might even just drop it point two five. I don't imagine they're going to drop half off, are they?

I guess it depends on just how urgent the need is. I think that the thing.

That could support large moves.

And I think, you know, I kind of agree that the first move is likely to be perhaps a cautious one, you know, to start start slowly and then accelerate, if you know, you keep getting the evidence that you know, rates should be lower. But the negel for them is just how far above a neutral cash rate they are. They would say themselves that they're basically double what they think is a long term term neutral rates. So they say long term neutrals about two point seventy five. We're

Yeah, I mean, it's all wreckord I've got. I mean, I'm no expert on these things. I do wonder whether you know, you mentioned that they might do it gently and then accelerate. I sometimes wonder whether they might have been better to go hard and then not so aggressive on the acceleration. But that's just you know, hindsight. It's

Now.

I know you're not going to give specific advice, but you could give some thoughts on this. Would it be wise to reinvest for a longer term, like five years instead of that one year that I usually go for, And let's assume that Ruth wants to keep her money saved in the savings for a long period of time.

I would have My non.

Specific advice would be if the bond markets are quite good right now, why wouldn't you have.

A crack at that? Or give us your thoughts, Amish, what do you reckon?

Yeah?

I think the.

Choice between term deposits and something like a bond or a fund that invests in bonds. One of the key different is to consider is liquidity. So you know we will have talked about this before, and you will have talked to others about it that you know, term deposits it's pretty strict in terms of your ability to access that money through the life of or the term of that deposit.

You know, it's it's essentially locked.

Away, whereas if you buy a bond or invest in a bond fund, you normally will have daily liquidity, so you'll be able to sell that if you want to.

And then have your money back within a couple of days.

So that's the first thing to consider. Am I getting when I go and say, as you know, sort of thought about if you wanted to go into a say even a two or a three year term deposit just for example. You know, am I getting compensated for not having access to that money for that period of time?

Are going to fall.

And we've already seen some reduction in term deposit and mortgage rates since that pivot by the RB.

I guess I was wondering because it was it seemed that just a few weeks ago, the conversations around bonds and everything was making them look making an un sexy product look like it wasn't such a bad idea. And you wonder if the interest rate drops quickly, how quickly that's sort of idea falls out of favor.

I don't know, Yeah, I think that that's.

A good point.

You know, generally, what will happen is that as the interest rates fall, you'll be if you're invested in a bond, that those are good times. You know you've got in when that interest rate is high, so you get to enjoy that sort of income. And then as interest rates drop, you get a capital gain because the value of that security goes up. And so there's a moment where you know, bonds just do really well because of both of those those channels working. But then when we get to the bottom,

Cash rate blummy.

Yeah, So let's say we.

Get there, then we would have a very different conversation about bonds because we would be thinking, right, I'm only getting something like maybe two or three percent in yield, what's the prospect of capital gain, which would mean, you know, you have to be thinking about yields falling from there. That's a different conversation. I mean, that's the kind of

Yeah. I tell you what.

We're going to take a call when we get back, and you can give us a call anytime if you want to disagree with what what Hamish was saying. I have your reckons as well. Wait if you agree, we love people who agree as well. I weight one hundred eighty ten eighty text nine two nine two. It's twenty two minutes. I get that right, Yeah, it's twenty two minutes to six. And welcome back to the Weekend Collective. This is smart Money with Hamish Pepper from Harbor Asset Management.

Anyway, let's take some calls. Glenn, Hello, good evening.

Actually, what are you going at point five in August?

What the hell?

No, I don't think we said point five?

Did we say point five in August? Did you say did Hamish say point five in August? Where you go, Hamish?

I think I think Tim offered up the possibility, but then I think the conclusion was perhaps that's too large, But yeah, I.

Doubt mate, Glenn.

I'm not.

I'm not the economist or a heart of ex income strategist. I'm just a guy just throwing some figures out for fun to hook you in to give us a call and well done, welcome.

Yeah, No, I think I think, Glenn, you know, ultimately I agree. I think it would be such a huge turn from you know, just the previous managery policy statement in May, the one we were talking about where they were thinking about pikes to in August be cutting by fifty.

I agree. I think that that is too much.

It's not a zero in terms of probability, but it's it's probably not the very very.

Hey, Glenn, guess what I'm going to go with it, because you know, when you expect the Warriors to win and they lose, and when you expect to lose and they win, we're not expecting a cut in the grate. So I'm going to go point twenty five on August fourteenth, or whatever it is.

What you've got, I think what you've got the of one something or has done nothing.

So I didn't quite catch that say that again.

The worries of have actually heard a coach who's done some good stuff, Adrian or he has done nothing. Here's the worst event governor in my life. He is horrendous.

Why is that from your point of view that he's the absolute worst?

He has just printed and kept low for too long. He watched what was happening overseas, didn't first sort to think about New Zealand as an export context. It just just followed the herd with overseas well. He didn't, for any of his own interpretation on it, any of the New Zealand's how our economy works is completely different area than out of the economy works has followed the crowd.

It was, Glenn, Is there any psychology that the fact that maybe because he went too long, too low for too long, that he's going to compensate by going on the quicker side with making an adjustment.

No, No, because he can't. He can't raise and then we get all the rates come through, and we have another a drought or a flood or whatever, and all of a sudden he looks in its three point two and he's got a cat again. Like that, credibility is completely at the window best different. So he won't do

So what would he do?

What could he do from here on in that might impress you? Okay, Glenn, call again, mate, that was that's fantastic. Love you love your takes on that stuff.

Yeah. I don't have any comment, Hamers.

No, not no, no.

No, no.

I mean I think look, part of what Glenn is saying is has been acknowledged by the ben Z themselves in terms of you know that that period through COVID where you know, and he picked up on not just rates being low, the official cash rate being at a quarter of a percent, but the fact that there was quantitative easing going on through that period in terms of, you know, an injection of money into into the financial system and all of that did did go on too long,

That Yeah, no, I've just been mischievous trying to drag you into having a having a cracket avera. It's just

And yeah, so I mean, if we build off you know, kind of that conversation with Glenn, I mean he was skeptical about whether they would cut this year at all. The financial markets have a very different view. They think there will be at least two twenty five basis point rate cuts by the November meeting, and in fact there's about a fifty percent chance of a further one before the end of the year.

So that's where financial markets are.

And then they continue on next year in terms of an assumption that their easing cycle continues. And it's with that that we've now started to see the banks come through with lower mortgage rates. Admittedly, you know, starting sort of somewhat slowly in terms of you know, the speed with which they were changing them, but also that the increments you know, perhaps for a lot of people out there aren't going to really change the change the kind of cash flow. But I think this is how it

What about in terms of bond markets and things like that, Well, how does that all respond to it?

And the and the term deposits.

Yeah, so, I mean exactly like we were kind of describing at the moment. You know, if you look at term deposits out to five years, you know, you've basically got your shorter.

Term ones something like you know, six or twelve months.

Still the best part of six percent, and then they come off down to around five percent over over that that five years. And so you know, as we go through a possible easing cycle which halves the ocr you know, let's let's call it to seventy five as where we get to you know, those term deposit rates have a lot of room you know, to four. So for example, you know, when you got to the bottom in terms of you know, the cash rate sitting.

At two point seventy five percent, you know.

You're probably really looking at say six or twelve month term deposit rates that were sort of that three to three and a half, so a lot lower than.

What we have today.

Hey, just on the motivating factors that are going to influence the Reserve Bank on whether.

They make a shift in the cash rate.

You know, we have business surveys that tell a story. What are what are your what are your informed formal observations, but also your casual ones as well, just from your neck of the woods.

The business surveys are just atrocious. We're talking about levels and business surveys that we haven't seen sometimes since these surveys have started, and most often it's the weakest sentiment since the global financial crisis.

So one a classic.

One which has been sort of highlighted recently is where you've got businesses from the manufacturing and the services sector asked about what's going on. You put those two things together into sort of a composite measure. You know, that thing not only looks as weak as the global financial crisis, if not slightly weaker, but it looks so so different to almost any other country in the world. Most other countries still have an economy that is expanding, that is growing.

And how much more of a problem is that because we are not a big economy either in terms of our size, does that mean we feel these fluctuals and these bad bits and news even worse in terms of our ability to recover.

Yeah, well, I mean one of the most interesting things recently is but you know, we are we're a small, open economy. We're heavily reliant on the health of the rest of the world. And luckily, you know, those economies that I was describing are still okay, China much less so, and that's having a sort of its own negative impact. But you know, if you think about, you know, sort of what is going on in terms of people's psyche.

Arrivals less departures.

You know, it was really high, right, it's now fallen to basically zero nothing. And it hasn't been because people have stopped arriving. People have continued to arrive at roughly the rates that we saw.

You know what it is.

It's worse than that, isn't it, Because we're all buggering off.

Ye at a rapid rate, a rapid rate.

And I think to me that speaks to just how weak we are compared to our trading partners, compared to places that Kiwis can go to relatively easy, easily, like Australia for example.

Gosh, oh wow, gosh, it's fascinating. In fact, you know, it's just some of the apocryphal stories like I went on holiday and yes, I'm lucky enough that we we love to go skiing, but we we didn't go Queenstown except for a couple of days. But when I was in Queenstown, I thought, boy, this place is a lot quieter than I recall, and it just you know that that's obviously borne out by the by the sort of things you're talking about.

Fascinating conversation, Amish. Thank you so much, mate.

No worries at all.

Pleasure to And if people want to check out your work and look at your funds or your research, that's harbor Asset dot co dot NZ.

Yep, that's the one. Yeah, hopefully all the information you need is on there.

Good on you. Hey, really enjoyed our chat this afternoon. Thanks so much, buddy.

Cheers done, every good one.

Yep, we'll be back in just a moment to wrap up. It's eight minutes to six news Talks. He'd be, yes, welcome back to the show. Well, that actually wraps up the smart money and the show for the weekend. But I'm grateful for the time and how much Pepper spent with us from harbor Asset Management. And as I say, you can go and check out harbor Asset dot cod it said, there's a lot of information there, a research and commentary and as well about the funds that you

Enjoy your evening and catch us soon.

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