Blood, Sugar, Brex-Magik: markets high on risk.

Blood, Sugar, Brex-Magik: markets high on risk.

“Temporarily blind, dimensions to discover, in time…”

Key points

• Financial markets are laced with red hot chilli pepper risks: including Brexit, US-China trade, and a loss of economic momentum.

• Central banks are changing course. And the RBNZ is about to cut rates at least twice. The asymmetric risks have simply become too large to ignore.

• Lower interest rates are a near-certainty. And we should see a volatile descent in the Kiwi dollar.

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“Misery is not my friend, But I'll break before I bend. What I see is insanity. Whatever happened to humanity.”

Inequality has worsened. The haves have a little more. The have nots have, well, not. Growth in income (wages) has been weak. The distribution of that poor income growth has barely “trickled down”. We have seen a populist revolt against the elite, the wealthy, and the immigrant. Votes for Brexit and Trump are directly linked to the struggling lower-to-middle classes. We have seen a lurch to the far right, and to the far left. We’re divided.

“Across Europe parties of the far left and the far right are seeking to exploit this opportunity — gathering support by feeding off an underlying and keenly felt sense among some people — often those on modest to low incomes living in relatively rich countries around the West — that these forces are not working for them… Those parties embrace the politics of division and despair and the sense among the public that mainstream political and business leaders have failed to comprehend their legitimate concerns for too long.” Theresa May, British PM.

The UK want out of the EU, maybe. And the US wants to make itself great again. Complicating the outlook is the loss in economic momentum. Political uncertainty is plaguing markets, and business confidence. Uncertainty kills confidence. And a lack of confidence kills growth. Forecasts for growth have been cut this year and next. Recent talk of monetary tightening has been side-lined, and now we talk of rate cuts. One thing we’re confident about, interest rates will fall further, and remain at or below historic lows for a very, very long time.

The RBNZ’s action man, Adrian Orr, is set to cut the OCR 50bps to 1.25%, in our view. Our clients ask: ‘how far can he go?’ We’d put a 40% chance of another 50bp cut in the OCR to 0.75% in 2020, if conditions worsen. Beyond there, the RBNZ could cut to 50bps, and would entertain the use of QE, currency intervention, and firing up Government investment. The RBNZ’s QE could buy Govt bonds with the understanding the Govt ramps up fiscal investment. And the RB can easily print and sell the currency. But we’re still quite some way away from entertaining QE. The point here is, we have plenty of ammunition if needed.

Currencies will attract volatility. The Kiwi flyer (currency) could hold up well in a world muddling through. But the Kiwi will drop like a stone in a disorderly world. Our currency will do what we need it to do, when we need it most. If not, the RBNZ will intervene. We forecast a volatile descent for the bird this year.The Kiwi should drop into the low 60s by year end. RBNZ rate cuts will accelerate the Kiwi’s decline. At 68c today, the risk is asymmetrically lower, in our opinion. Threats of recession offshore, could see the bird drop into the 50s. Against the Aussie battler, the Kiwi was dominant – like a rampaging All Black pack trampling over a weakened Wallaby. We’d love to see NZDAUD parity. But such a strong NZD/AUD hurts our manufactured exports. A strong NZD/AUD is great if you’re wanting to buy an Australian canary yellow cricket jersey, loose fitting for underarm bowling, with a complimentary strip of sandpaper. But generally, we prefer a weaker Kiwi/Aussie cross. Because it helps our Kiwi expats in Australia import the black jerseys.

To read more, please click here or open the pdf below.

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