Interest Rate Surprise Highlights the Real Risk

Yes, interest rates. Be careful what you wish for; you might just get it.

I was surprised to see the Reserve Bank of New Zealand leave the OCR rate at 1%. There was expectation — at least by some 65% of analysts — that the Bank would follow Australia down to 0.75%.

When you’re building share portfolios globally, one thing that can help is to own a stronger currency. The NZD just got that bit stronger and made the buy side in this currency a little easier.

In particular, the AUD.NZD cross that had been hovering upwards of 1.08 is now down toward 1.065 at time of writing.

What does that mean? If you’re looking to buy ASX stocks with NZD, it’s easier buying AUD at 1.06 (or ideally 1.03) than it is at 1.09. And when interest rates converge at some point — which they may well do with a worsening trade war situation impacting China — there’s a chance you could capture upside.

Why did the Reserve Bank extend a breather for interest rates?

Their statement mentions employment ‘remaining around its maximum sustainable level’ and ‘the effect of low interest rates on financial stability’.

They also mentioned the need to wait and see on the previous cut streaming through the economy.

They didn’t have to wait long.

The day after, REINZ released numbers showing the median house price in New Zealand has now climbed above $600,000. And even Auckland prices are on the move again.

Governor Orr has before expressed concern with debt levels — in particular, many mortgages. With the bank set to ease loan-to-value restrictions later this month, even lower interest rates could inflate a powder keg.

Holding the OCR will inevitably lead to some mortgage-rate rises as banks manage the forward risk of the large amount of re-fixing expected over summer. This may gently apply the brakes on further house price escalation. And contain the risk of a blow up.

Risk of a blow-up?

Mortgage debt on New Zealand housing seems sustainable with average fixed rates below 5%.

The concern is if rates go north of 8% again.

This seems a long way off. But the world is currently in a situation of constrained demand. The two largest economies (the US and China) are at loggerheads over trade.

Countries like New Zealand and Australia — dependent on Chinese export orders — are using low interest rates to shore up domestic demand. As Europe has done to try and combat slow growth.

In Australasia, this is a new game in the machine. And one that we’re not used to playing.

While the Reserve Bank can alter the OCR at will, it is not a perfect control.

There is also the risk premium. Generally, this is the extra interest lenders charge above the government rate.

An economic shock, such as a Chinese import dry-up, could increase the risk premium in Australasia.

In South Africa, mortgage rates sit at around 10%. The risk premium is one reason.

The current game is not the real thing.

It’s rigged to keep the wheels on the road. High debt to pay for unaffordable housing. Mass migration to shore up domestic demand. High business taxes and compliance to feed a well-paid bureaucratic clique. Little relief for innovators who create real value. And an OCR calculation balancing inflation and egged-on debt.

As investors, all we can do is take advantage when value appears. There are limits on how deep interest rates can get cut in a debt-addicted country. But when investing globally, any resulting strength of the dollar is welcome.

Regards,

Simon Angelo

Editor, WealthMorning.com


Simon is the editor of Wealth Morning and has been investing in the markets since he was 17. He recently spent a couple of years working in the hedge fund industry in Europe. Before this he owned an award-winning professional services business and online learning company in Auckland for 20 years. He has completed the Certificate in Discretionary Investment Management from the Personal Finance Society (UK), has written a bestselling book and manages global share portfolios.


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