Harbour Outlook: A rebound amid uncertainty

 

Key market movements

• Global equities rebounded in January. The MSCI All Country World Index (ACWI) increased 2.4% last month, in New Zealand dollar-unhedged terms. With the NZD strengthening through January, returns in hedged terms were 3.3% for the month.
• Locally, the New Zealand equity market weakened with the S&P/NZX 50 Gross Index (including imputation credits) down 0.9% in January. In contrast, Australian equities had a cracking month with the S&P/ASX 200 Index up 4.6% (4.1% in NZD terms).
• NZ bond returns were flat in January, measured by the Bloomberg NZ Bond Composite 0+ Yr Index. Global bonds did better with the Bloomberg Global Aggregate Bond Index (hedged to NZD) up 0.4% as US 10-year Treasury yields dropped slightly in the month to finish at 4.54%.

Key developments

The Fed is in no hurry to cut rates as the US economy continues to grow above trend and inflation progress to target has stalled. At the January meeting press conference, Fed Chair Powell described the policy rate as “very well calibrated”, acknowledging it was “meaningfully above neutral” and wanting to see further progress on inflation. US GDP expanded at an annualised 2.3% in Q4 and is tracking at almost 3% this quarter. The labour market remains healthy and, as a result, inflation progress towards the Fed’s 2% target has stalled in recent months with core services and shelter prices remaining sticky. Higher energy prices also haven’t helped.

Looking ahead, tariffs are an increasingly important part of the Fed’s thinking, with Powell noting the range of possibilities is “very, very wide”. Trump has delayed the imposition of 25% tariffs on imported goods from Canada (10% for Canadian energy) and Mexico until 1 March, from 1 February, as both countries promised more border control support to limit the flow of Fentanyl and illegal migrants into the US. China, however, had an additional 10% tariff applied to its exports to the US for which it responded with largely symbolic tariffs of its own, perhaps suggesting China has more to lose from a trade war. The tariffs for the three countries are estimated to impact US$1.4trn of imported goods, three times the value of mainly Chinese goods that Trump targeted in 2018. Barclays estimate the new tariffs may reduce US GDP by 25-50bp and increase inflation by 35-40bp, excluding second order effects.

The RBNZ remains on track to take the OCR a lot lower with inflation at target and growing spare economic capacity. Headline inflation remained at 2.2% y/y in Q4, and core measures are now either inside the target band (CPI ex food and fuel, trimmed mean, weighted median and 2-year expectations) or very close (sectoral factor model). The NZ labour market continued to loosen in Q4 with the unemployment rate increasing to 5.1%, from 4.8%, driven by further job losses. Productivity-adjusted wages are running at 3.0% y/y, continuing to converge on their long-run average of 2.2%. All up, the data suggest there is plenty of spare economic capacity that should ensure core inflation will soon be at the RBNZ’s 2% target. The market currently implies a 50bp cut at the February MPS meeting, taking the OCR to 3.75% and a terminal OCR of less than 3%, close to our view of 2.75%.