Harbour:The methadone approach to market recovery

Key points:

• While developments in Europe drove NZ fixed interest markets in 2011, the future of the Quantitative Easing (QE) in the US will be a key driver in 2012.
• As the size of QE has grown since the start of the GFC, markets and the economy have become more dependent, increasing the challenge of QE exit.
• The decision as to when to wean the market off QE will depend on the prospects for US unemployment and inflation, which are noticeably better than when the Fed embarked on QE1 and QE2.
• However, the Fed will be cautious about withdrawing the drug from the patient, and attempt to guard against a sharp rise in long-term interest rates before the economy can stand on its own feet.

With little news on the local front to change the RBNZ's intention to keep the Official Cash Rate (OCR) on hold until the end of 2012, the focus of the local fixed interest market has been on global developments.  

While developments in Europe drove NZ fixed interest markets in 2011, the future of the Quantitative Easing (QE) in the US will be a key driver in 2012, particularly given the tight relationship between US and NZ government bond yields (Chart 1). Over the course of March there has been heightened speculation about how long the stimulus from QE will remain and when the US Federal Reserve will eventually exit QE.