Harbour Outlook: So much for the Christmas rally

By Hamish Pepper 

Key market movements

• The MSCI All Country World Index (ACWI) increased 3.1% last month, in New Zealand dollar-unhedged terms. The gain, however, was entirely due to a sharp drop in the NZD with the index falling 1.7% in NZD-hedged terms in December – so much for the Christmas rally!
• Locally, the New Zealand equity market eked out further gains in December with the S&P/NZX 50 Gross Index (including imputation credits) up 0.4%. Australian equities had a disappointing month with the S&P/ASX 200 Index down 3.2% (-2.6% in NZD terms).
• NZ bonds registered notable outperformance versus their global counterparts in December. The Bloomberg NZ Bond Composite 0+ Yr Index gained 0.6%, despite a 3bp lift in 10-year NZGB yield to 4.41%. The Bloomberg Global Aggregate Bond Index (hedged to NZD) fell 0.9% as US 10-year Treasury yields gained 40bp in the month to finish at 4.57%.

Key developments

The Fed is likely close to the end of its easing cycle as growth remains resilient and progress on returning inflation to 2% has stalled. At its December meeting the Fed cut rates by 25bp to 4.5% but forecast just 50bp of further easing through next year, 50bp less than the previous projections made in September. In the press conference, Fed Chair Powell emphasised a cautious approach to further rate cuts as progress on getting inflation back to the 2% target had stalled. The Fed’s preferred measure of core inflation turned higher in recent months and currently sits at 2.8% y/y – perhaps not surprising given the labour market remains healthy, and the economy continues to grow above trend. Trump policies represent additional inflation risks that some Fed official have started to incorporate into their thinking.

The Australian economy may finally be cracking, bringing forward expectations of RBA easing. Australian GDP grew just 0.8% y/y in Q3, vs. RBA expectations of 1.1%, as households continue to feel the pinch of lower real wages and high mortgage rates. Pressure is also building in the housing market as these dynamics combine with declining population growth to cause some of the first house price declines in Sydney and Melbourne that we have seen this cycle. While the unemployment rate unexpectedly dropped to 3.9% in November, from 4.1%, the market still prices a better than 50% chance of the first RBA rate cut to happen in February.

The latest NZ GDP numbers showed economic momentum took a sharp downward turn in the middle of 2024, likely encouraging faster RBNZ easing. GDP dropped by more than 2% over Q2 and Q3, versus RBNZ estimates of 0.4%. The weakness was relatively broad based with primary industries the only area of strength. While upward revisions to the prior two years mean the level of GDP is not all that different to RBNZ expectations, the rapid loss of momentum is likely to raise alarm and encourage a faster easing cycle than forecast in the November MPS. The market now prices a small chance of a 75bp rate cut in February, conscious that the current OCR of 4.25% is still well above neutral and looking increasingly inappropriate for a weak economy with inflation close to target.