Higher interest rates under certain political outcomes

9 October 2017

The economic case for higher US short-term and long-term interest rates was perversely reinforced by the latest US employment numbers released on Friday for the month of September. Whilst 30,000 fewer jobs was the result for the month that was badly hit by adverse weather events in southern US, the overall unemployment rate reduced to 4.2%, the lowest level since 2001. Wages also increased and this is the sort of evidence the Federal Reserve have been expecting and it is why they have stuck to further interest rate hikes this year and next year, despite the markets’ contrary view for most of 2017. The Fed are correct and the US interest rate market has been wrong all along in my view. US 10-year Treasury bond yields increased again to 2.36% following Friday’s jobs data and further increases seem likely as stronger US economic data sways the markets to re-price the previous pessimism. The implications for the New Zealand interest rate yield curve are clear, higher longer-term rates driven by US increases and our short-term interest rates remain stable until the RBNZ are convinced that higher inflation is back on the cards. Currently the RBNZ do not forecast annual inflation to get back above 2.00% until sometime in 2019.

If the political outcome over the next few weeks is a change of Government to a Labour/Greens/NZ First combination one would have to expect inflation to be on the increase a lot earlier than 2019. Firstly the expected lower exchange rate to a TWI in the low 70’s (currently 74.7) would have the RBNZ forecasters hastily revising their tradable inflation numbers higher. Policies artificially curtailing immigration inflows would reduce the labour supply in the economy, sending wages and thus consumer prices higher as well. Weaker fiscal policies from a more left-leaning Government would reverse large budget surpluses to deficits, which in turn adversely impacts New Zealand bond’s risk premium to US bonds i.e. a higher margin.

Borrowers and investors should expect both short-term and long-term interest rates to be higher earlier under a scenario that Winston goes with the Labour/Greens block.


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