While still loose, financials have tightened via a higher New Zealand dollar (NZD) and interest rates in the past few months. The interest rates borrowers face have still pushed lower though.
The NZD has risen to 0.73-0.74 against the United States dollar. The NZD on a trade weighted basis is up 6% in four months. Most world prices for NZ’s commodity exports have been on the ascent, led by dairy, so commodity linked currencies have risen.
The market has gone from pricing in a negative OCR to the next move being a hike. The actual OCR has not changed at 0.25%, but expectations where it could be in 2021 have gone from -0.2% to around 0.25, a turnaround of more than a 50-basis points.
Long-dated interest rates, the 5-year and 10-year government bond have risen more than 100 basis points.
Some of these moves will unwind with the trajectory for the economy more uncertain, given the shift in alert levels, and expected negative gross domestic product (GDP) for the March 2021 quarter.
But clearly markets have a different tone, despite inherent uncertainty on the covid-19 front, buying into the concept of reflation – expanding output and a hint of inflation – around the globe. We might not quite be fully at that juncture, but markets are forward looking. US 10-year bonds and Australian equivalents are up sharply too.
NZ is clearly an outperformer around the globe, so we should not be surprised to see market sentiment change. Dovish overtures by the RBNZ noting prolonged monetary policy stimulus would be necessary did little to stop a higher NZD and bond yields.
The movement in long-term wholesale interest rates and shifting expectations for the OCR has some asking whether the interest rates borrowers face will be moving up, and particularly in areas where there is less competitive pressure and greater difficulty involved in shifting banks, such as the agriculture sector.
While wholesale interest rates have certainly moved and this can pre-empt borrowing rates shifting, the key variable to keep an eye on is bank funding costs.
Bank funding costs remain low and are still decreasing as banks shed term deposits currently costing circa 80-90 basis points.
Cheap local sources of funding are available. Deposit rates declined over 2020 and there is limited sign of a turn in 2021.
Bank funding costs continue to benefit as customers switch out of term deposits to hoarding cash in savings and transaction accounts. The latter two offer little yield, which means zippo cost to banks, but give people flexibility and time to decide what to do with the money.
Total deposits with banks were up $18 billion in the second half of 2020 and $39b in the year. Transaction balances rose $37b (which you get zero on) and savings balances (almost zero) $27b.
Term deposit balances fell $25b in 2020, a fall of almost 13%.
That switch is providing a lot of cheap funding.
The RBNZ stands prepared to offer cheap funding to banks via the Funding for Lending Programme (FLP) at the OCR of 0.25%, which is well below term deposit rates.
There is scant sign of stress in offshore funding markets, though rising wholesale rates will be adding to funding costs, somewhat offsetting the benefit of the switching mentioned earlier.
Risk premia metrics (the additional compensation investors require for risky investments) are showing less funding stress in the banking system, helped by the RBNZ.
There seems little pressing need for interest rates borrowers face to move up in the current funding environment. That could change if we start seeing sustained nudges up in deposit rates.
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