What US Fed rate rise will mean for NZ investors

OPINION

The end of the year is fast approaching. A key question facing financial markets is whether Janet Yellen will deliver before Christmas the first rate hike by the US Federal Reserve in 10 years, ending seven years with interest rates percentages near zero. 

So what are the implications for such an historic decision of the New Zealand economy and markets?

The chance of the US Federal Reserve lifting interest rates has risen dramatically in recent weeks.  Back in September, they looked on course to put up interest rates but this was scuppered by a backdrop of high market volatility, thin liquidity, and concerns about a hard landing in China. 

At the end of October, the US Fed surprised markets by taking the unusual step of explicitly spelling out what they needed to see to put up rates at their next meeting; namely, continued progress towards their dual mandate of 2% inflation and full employment.

Soon after, the US Fed got the news it was looking for. The US jobs report for October painted a very strong picture of the US economy, generating 270,000 new jobs in October and unemployment fell to just 5% – half its peak before the global financial crisis. 

The case for keeping US interest rates at all-time lows is now very weak.  While nothing in markets is a certainty, something dramatic would now need to happen to stop the US Fed putting up interest rates in December.

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A key reason this matters for New Zealand is that the sharemarket and credit markets are influenced by global financial sentiment.

For as long as the market has speculated about the chance of the US Fed putting up interest rates, investors have worried that this could be the trigger that spooks markets and ends the long bull run in equity markets. 

For this reason, if the US Fed does lift rates, it is likely to be at pains to emphasise that this is likely to be a slow, cautious process, with interest rates unlikely to get anywhere near back to their pre-GFC levels.  In other words, there will still be plenty of monetary stimulus to placate markets.

However, there is one snag. At the moment, inflation pressures in the US and around the world remain benign. If that were to change, and US inflation and wage pressures were to build, it would remove the luxury of delivering a cautious tightening cycle. 

Indeed, it could force the Fed’s hand and prompt a sharper rise in interest rates, which would pose a greater danger of triggering a correction in global markets.

Another key implication for the New Zealand economy from any decision on US interest rates is the outlook for the New Zealand dollar.

Since the middle of 2014, the US dollar has been strengthening, on the back of solid US economic growth and building expectations that the US Fed will start lifting interest rates. 

This broad US dollar strength in part explains why the New Zealand dollar has weakened since its peak earlier in the year. 

This is a welcome development. It helps with New Zealand’s transition toward a more sustainable exchange rate and is more consistent with the sharp fall in dairy prices since 2014.  

Reserve Bank governor Graeme Wheeler has made no secret of the fact that he would like to see the US Fed get on with the job, which would strengthen the US dollar and may result in a lower kiwi dollar. 

So the US Fed lifting rates in December would definitely be seen as a Christmas present for Mr Wheeler. 

It would also leave one less thing for him to worry about over the summer break. 

All that remains is the checklist from last week’s Financial Stability Report – high Auckland house prices, low dairy prices and perennial worries about China. 

Christian Hawkesby is a director at Harbour Asset Management. This column does not constitute advice to any person.

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