NZ Super Fund chief economist Mike Frith questions whether the government will change its stance on debt-to-GDP targets.
We’ve made it through the first quarter of the calendar year, which, in this part of the world at least, means summer is coming to an end and autumn/fall is at hand. It also means we are three-quarters of the way through our financial year, which makes for a good time to take stock of what is happening in global and local markets.
It’s fair to say the past six months has been a bit of a roller coaster, and there is a real sense, locally and internationally, that an economic chill is on its way.
If I were to revisit 2018, I would say the major driver of markets was the US Federal Reserve, which took advantage of fiscally driven tailwinds to bank some policy rate ammunition. A Fed funds rate of 2.25-2.5 % doesn’t sound like much but, when it comes on the back of 100 basis points of increases over the previous 12 months in a world still highly debt-laden, then the shockwaves that went through markets in the last quarter of 2019 were a matter of when, not if.
When the market reacted badly, the Fed responded quickly and put a stop to its normalisation process – policy rates and balance sheet. The European Central Bank also made dovish noises and the kiss of life was given to equity markets, which rallied hard over the first quarter of 2019.
Global equity markets that had sold off over 13% in the December quarter, rebounded almost 12% over the March quarter.
We certainly felt that volatility at the NZ Super Fund. We went from a net valuation of $41 billion at the start of October to $37b by the end of December and back to over $41b at the end of March.
Not fun for the weak of heart but something our investment framework is designed to withstand.
In the fund’s annual report last year we talked about the possibility of significant market volatility and what that would mean for our short-term returns. Most importantly though, we also talked about our biggest risk – losing our nerve, closing our positions out, and locking in our losses. As a fund with no substantial withdrawals until the 2030s, we can take a long-term view and look to profit from financial markets that dart around as they have over the past six months.
So we have come through this period relatively unscathed but it’s fair to say market participants and commentators have been a little bruised and concerned about global economic prospects.
The US benchmark 10-year bond yield rallied (fell) 86 basis points from the start of November to the end of March as markets bought into the Fed’s dovish view and added to the negative sentiment emanating out of Europe and China.
The 10-year three-month yield curve briefly inverted, bringing with it alarm bells of a forthcoming recession, as has been seen in the past. Markets are now pricing the next move by the Fed to be downward by the end of this year.
Locally, the story is much the same. The smell of weaker domestic demand and business confidence has seen the Reserve Bank go all dovish and commentators are now calling for official cash rates cuts this year, and next year in some cases, to prop up economic growth.
I’ve often found that at this point in the cycle, it is not unusual to see conflicting data outturns – some pointing at weakness, some at strength or stability. As a result, you tend to see markets whipsaw around according to the most recent data points.
But the underlying momentum remains – the recent US jobs report was good and global commentators haven’t yet taken the axe to their growth forecasts. Additionally, it appears the US and China are near to resolving their trade spat, which will stabilise global growth and provide a tonic to the global environment
As a result, I’m not expecting the wheels to come off the local or global economy. And, even if there is a wobble, central banks seem prepared to respond, albeit only the dollar-bloc countries – the US, Canada, New Zealand and Australia – really have any sort of policy ammunition. So if we see a run of weak data – might only need two or three outturns – the trigger will probably be pulled.
On the fiscal front, many western governments have high debt levels and I’m not sure how much headroom they have. You would normally want governments to run surpluses and pay off debt when economies grow so they can respond when economies weaken but that hasn’t happened over the past few years.
In New Zealand, successive governments have paid down debt so there is plenty of headroom to provide fiscal stimulus to the local economy, should it be needed. However, the current government has set its stall on its debt-to-GDP targets. It will be interesting to see whether that stance changes if the domestic economy weakens, as expected by the Reserve Bank, and businesses start laying off employees.
So what to expect for the remainder of 2019 – a truce between China and the US and momentum will keep the global environment stable, while central banks will retain a dovish tone. Markets will bounce around a bit but I expect the year to close out not widely different to where we are now.
Mike Frith is chief economist for the NZ Superannuation Fund.
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