We are now seeing the “whites of the eyes” of global inflation
In late 2016 Janet Yellen, the Head of the US Federal Open Market Committee (FOMC), stated that there would not be rate hikes until they saw the “whites of the eyes” of inflation. In late February 2017 they finally saw this when the US jobless claims came in at 246,000, the lowest it has been in nearly 44 years. This higher level of US employment is expected to lead to increased wage inflation which in turn adds pressure to the Fed to increase cash rates.
This better than expected jobless claims number has led the market to now price-in a 90%+ chance of a US rate rise in March. As shown in the table below, this result has caught the market by surprise, given it had priced-in only a 25% chance at the start of February. An increase in the cash rate was all but confirmed with a better than expected increase in the US private payrolls number on 8 March. The probability of 3 rate hikes in 2017 has now jumped up from 25% in February to 35% in March.
Why does this matter?
As we have mentioned previously, the US 10 year bond rate is very closely correlated to longer-term NZ interest rates. Therefore an increase in interest rates in the US can also be expected to lead to an increase in mortgage rates in NZ . Indeed we have seen this already with 2, 3 and 5-year mortgage rates increasing over the past 6 months. Interestingly the floating and 1 year fixed rates have moved only slightly. This is because the short end of the curve is driven more by the RBNZ cash rate movement, with the longer end driven by offshore markets.
These sorts of small moves in mortgage rates will start to have a larger impact on the disposable income of the average Auckland property owner who, as shown in the chart below, is currently spending c50% of their disposable income on mortgage payments.
Lastly, on NZ housing we have heard that banks are tightening their lending practices, as they endeavour to improve the credit quality of their books. This has also been happening in Australia where the Commonwealth Bank of Australia (CBA) has frozen new lending to property investors looking to switch banks and refinance their mortgages.
Latest Dairy Auction
In the March Global Dairy Auction, we saw a dramatic stalling of the recent dairy price rally, with Whole Milk Powder (WMP) prices falling 12.4% and some analysts struggling to see any short term pick up in this sector, as market supply exceeds demand in the short term.
This result has seen local analysts reduce their forecasted payout for 2017 and supports Fonterra’s decision to hold the expected payout at $6.00 p/kgms last month. The current level of volatility in the prices is being driven by increased uncertainty around possible supply and demand levels, with prices ranging from a high of $8.40 p/kgms in 2014, to a low of $3.90 p/kgms in 2016. This is leaving farmers cautious about expansion and the banks tentative about calculating the level of debt farms can carry.
What’s happening in the Eurozone?
Data has been improving across the board with all EU member states now moving from a deflationary environment to inflationary and jobless numbers appear to be slowly improving across the board.
This is turn is putting pressure on Mario Draghi, the President of the European Central Bank (ECB), to start considering reducing or even removing the cUS$95 billion per month of quantitative easing that the ECB has been pumping into the markets to assist the drive for EU recovery. It is expected that this tightening will commence in 2018 which will start putting further pressure on interest rates around the world to move back to more normalised pre-quantitative easing levels.
Speaking of inflation, fixed interest markets continue to defy logic as shown by the recent fall in the 2- Year German Government Bond yield. This is now approaching -1% p.a. in an economy where inflation has ticked up to around the 2% p.a. level. So investors are receiving a real return of -3% on these securities without allowing for tax!
Brexit – discussions continue
This month we had expected to see the next chapter in the ongoing plans for Britain to leave the EU (Brexit). Teresa May (UK Prime Minister) was expected to invoke Article 50 later this month. If enactioned it will give the UK 2 years to negotiate their full exit from the European Union. This process has been delayed as Teresa May has fought a battle in the local courts to allow her to make the final decision to leave. However, the courts have ruled that “parliament” and not “one party” has to approve the UK’s departure from the EU. This view was further ratified this week when the House of Lords voted in favour of a requiring a “meaningful” parliamentary vote on the final terms of the agreement with the EU around the UK’s withdrawal.
It is still expected that Parliament will vote to leave the EU, but the current debate is around whether they will leave and accept the deal the EU has put forward, or if they will leave with no deal. It is fair to say that this issue is far from resolved and we may see the expected date for invoking Article 50 pushed out to later this year.
The Trump Trade
The US share markets continue to move higher following the election in November 16. Whatever we all think of Trump, the share market loves him with the US Index up circa +4% for February and +12% since the election! We feel it is time to be very cautious being overweight equities at these heady levels.
Even sectors which initially sold off following the election have joined the party, as shown by the S&P Pharmaceuticals Index below. Note the rally (a c.+12% bounce) following Trump’s meeting on 31 January with Pharma-industry executives. Prior to this meeting he was going to get hard on prices. Post this meeting he was much more supportive of deregulating the industry and not wanting to be seen to be “price fixing”.
PWA continues to grow and is on the move
Last month PWA welcomed Grant Lowe, our 4th Authorised Financial Adviser (AFA), to the team. Grant has worked in financial markets for 20 years both in London and New Zealand, with 13 years’ experience as an investment adviser. Most recently he has spent the last nine years working for a large local Private Bank, where he advised and managed portfolios for High Net Worth individuals, Family Offices, Community and Charitable Trusts.
Our growth has meant a need for more space and a chance to create a home of our own. Next month PWA will be moving into newly refurbished character offices at Suite 1, Level 1, 1 Faraday Street, Parnell (on the corner of Faraday Street and St Georges Bay Road). The St Georges Bay Road precinct is undergoing a lot of re-development with a mix of both new and old style architecture.