Salt Funds Management Limited

The Bank of England continued their cautious approach to setting monetary policy at the December meeting. In a 6:3 decision to hold rates unchanged, the best description of the outcome is a dovish hold. That balance recognises the recent tick up in both headline and core inflation amid a deteriorating growth outlook. The labour market remains critical to the outlook. Looking at some of the forward indicators, I agree with the Committee’s rearticulation of the labour market from “tight” to “balanced” but expect the cautious approach to prevail. Expect a 25bp cut in February.

This week’s NZ GDP data incorporated significant upward revisions to history that means the recession has come later and been deeper than previously reported but has left the level of GDP in broadly the same place. That profile, however, does seem to cement in a 50bp cut in the OCR at the RBNZ’s February meeting. This week also saw the Treasury’s latest fiscal update, showing the massive task ahead for the Government in achieving fiscal consolidation while meeting our many fiscal challenges in a weak economy.

On the back of today’s GDP result, I’ve firmed up the likelihood of a 50bp cut in February (I’d still been flirting with 25bp) and added in an extra 25bp cut the second quarter. That means a terminal rate of 3.25% vs. the RBNZ’s 3.1% in the November MPS. Neither here nor there, really. It’s not the level of GDP that’s the problem – as I said earlier today, the net impact of the upward revisions plus the later, deeper recession has left GDP in September higher than the old data showed it in June - the problem is the new strongly negative growth trajectory of the last 6 months suggests to me another negative is possible in the December quarter. Time will tell. What I would add is that the further rates go below 3.5% (where I’m guessing neutral is), the more likely it is we will be back to rate hikes in 2026.  I haven’t pencilled any hikes in yet, but watch this space.

As we often say, perhaps needlessly, what happens in America matters. The ongoing recalibration of the outlook for US monetary policy is adding to the post-election resurgence in the USD. At 0.566, the Kiwi is now at its lowest since the GFC. 

NZ GDP came in much weaker than expected in the September quarter, contracting -1.0% q/q. Average market expectations were for a contraction of around -0.4%. To add to the recent weakness, the June quarter was revised down from -0.2% to -1.1%. Annual growth came in at -1.5% in the year to September. However, and it’s a big however, Stats NZ has incorporated its previously signalled revisions to GDP that has lifted the level of activity over the last two years, meaning that the recession has now come later and been deeper. Note that for all that, the level of GDP is higher in September this year than the old data had it at June. This profile better fits our belief that the worst part of the recession would be in the middle of 2024 (in fact it is now the only recession in the data as previous technical recessions have been revised away), albeit deeper. This profile validates the RBNZ’s move to start cutting rates in August. More on the monetary policy outlook later.

Today’s FOMC meeting is the first since the election and therefore the first to have any firm idea of the policy program for the next 4 years. I summarise my take on the implications of the President-elect’s policy initiatives in the table below. Today’s hawkish statement shouldn’t have surprised anybody.

The top risk to US equities we identified back in October is “an indication that the U.S. economy is re-accelerating and removing the need for larger rate cuts.” US shares are selling off by around 3% today on more market acknowledgement of the reality of that risk, particularly after their very strong year to date performance. NZ dollar and other currencies are also dropping, with NZD now down over 10% year to date versus the rampant greenback. The silver lining is the boost to unhedged US asset returns for NZ investors.

As was widely expected by markets, the December FOMC delivered a 25bp cut to the Fed funds rate and delivered, in my view, an appropriately hawkish statement. The accompanying Summary of Economic Projections showed higher near-term inflation, lower near-term unemployment, fewer rate cuts across the forecast horizon (only two 25bp cuts next year) and a higher terminal (neutral) rate at 3.0%, up from 2.9% in September. Hard to disagree with any that. Here’s the dots:

NZ’s current account deficit showed a small improvement over the September quarter, coming in at -6.4% of GDP, up from a revised -6.6% of GDP in the two prior quarters. This is in line with our view of a reasonably fast partial improvement from the lows of -9.2% of GDP at the end of 2022, followed by a hard grind higher back to more sustainable levels. This makes grim reading, especially following yesterday’s confirmation of a significant structural deficit in the Government’s fiscal accounts. Rating agencies are no doubt watching closely.

Today’s Half-Year Economic and Fiscal Update (HYEFU) underlines the structural nature of New Zealand’s fiscal deficit, and the challenge ahead for the Government in balancing the achievement of necessary fiscal consolidation at the same times as meeting increasing fiscal challenges.  Key points of today’s release as follows: ▪️ The Treasury’s economic growth forecasts have been downgraded significantly. Regular readers will be aware we have argued ever since the 2022 Budget that the Treasury has been too optimistic on the growth outlook. That has led to ongoing downgrades. This latest set of forecasts are still higher than ours, but we are now a lot closer. The trajectory is broadly similar to ours too in the sense that growth picks up through next year as the economy hits something of a sweet spot (our words) as lower interest rates feed through and as recently created spare capacity is absorbed. Growth then starts to hit capacity constraints in 2026, borne of ongoing moribund (my word again) productivity growth. ▪️ Ongoing downgrades to growth have led to ongoing downgrades to the fiscal outlook, including bigger deficits, delays to the return to surplus and higher debt levels. Today is no different. The Government’s new deficit measure OBEGALx (which excludes ACC expenses and revenues) returns to surplus in Fiscal Year 2028/29. The old OBEGAL measure does not return to surplus in the forecast period. Net debt now peaks at 46.5% of GDP in FY 2026/27 and falls to 45.2% of GDP by the end of the forecast period. Remember, the Government’s net debt target is to be below 40% of GDP. ▪️ The big news for markets is that NZ Debt Management has lifted their bond issuance guidance by $20 billion. That is more than twice my expectations. ▪️ The Government faces a massive challenge in achieving necessary fiscal consolidation at the same time as meeting the challenges of a significant infrastructure deficit, an ageing population, climate change commitments, rising demand for quality public services, alongside an ongoing commitment to current pension entitlements. The squaring of the circle is becoming increasingly difficult, with only three options available: to improve (per capita) GDP growth, raise more revenue, or re-prioritise existing expenditure.  The first is hard and, for politicians, the other two are just as challenging.