Harbour Investment Outlook: Higher for longer, but how much longer?

New Zealand and Australian share market returns over the month were dominated by the negative impact of higher long-term government bond yields on valuations. Higher bond yields increase the return required by investors to put their funds into shares. Factors influencing the sharp increase in bond yields included signalling from central banks that official cash rates need to stay higher for longer to offset sticky inflation, the increasing US Government budget deficit requiring increased bond issuance to fund it and oil prices increasing from below US$70/barrel in June to above US$90 by late September.

Central banks have started to diverge over the past month. At one end of the spectrum is the US Federal Reserve that struck a more hawkish tone at its September policy meeting by upgrading its economic forecasts and noting that further rate hikes may be required to meet its objectives. At the other end of the spectrum, the European Central Bank indicated its tightening cycle may be finished with the current level of interest rates seen as making “a substantial contribution to the timely return of inflation to the target.” After recently abandoning yield curve control, the Bank of Japan has returned to its dovish ways by maintaining its ultra-loose monetary policy and noting that it is “yet to foresee inflation stably and sustainably” achieving the 2% target.

The global economy continues to slow in an uneven way. The US economy remains the clear outperformer with Q3 GDP tracking at close to 5% growth on an annualised basis and a recession unlikely any time soon. There are some signs of loosening in the US labour market, however. The unemployment rate increased to 3.8% in August. A large drop in the quit rate also suggests that US wage growth should moderate meaningfully over the coming six months. Elsewhere, Chinese economic activity appears to have stabilised at low levels with the help of some policy support, but a rebound is unlikely. European growth looks to have stalled with both manufacturing and services PMIs remaining in contractionary territory.

A surprisingly strong Q2 GDP print has created some questioning over whether New Zealand monetary policy settings are sufficiently tight. The 0.9% q/q growth represented a 0.4 percentage point upside surprise to the RBNZ August MPS forecasts and, with positive revisions to prior quarters, implies a higher path for the OCR. Other developments since the August MPS, however, augur for a lower path. We don’t think Chinese economic weakness and lower commodity prices were sufficiently captured in the August MPS and nor was the tightening in monetary conditions that has occurred since then.