Weekly Economic Commentary - The Government, the virus and the QE program.

 
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Weekly Economic Commentary - The Government, the virus and the QE program.
Kahurangi National Park, New Zealand

         Weekly Economic
         Commentary.
         The Government, the virus and the QE program.

            After a tumultuous few weeks, financial markets have calmed again. In part, that’s due to
            signs that the daily number of new Covid-19 infections globally is flattening off. However, the
            major factor that has soothed frazzled nerves in financial markets has been the extraordinary
            level of fiscal and monetary stimulus that has been announced globally in recent weeks. Those
            measures have supported a rally in equity markets, though major indices are still well down on
            their pre-outbreak highs and they remain choppy.

         Financial markets sentiment remains fragile and will be             sector. Both the wage scheme and the business loan scheme
         repeatedly tested over the months ahead as the extent of the        appear to be working smoothly, with massive take up of both.
         downturn in economic conditions becomes clearer and weak            The major banks are also providing mortgage repayment
         economic data emerges. The strain on businesses’ financial          deferrals of up to six months for households, which we expect
         position is already evident, with growing reports of layoffs and    will also be heavily subscribed.
         some business closures already occurring. We expect to see
         more of this in the coming weeks.                                   These schemes make sense. They will allow businesses
                                                                             and households to tide themselves over through a period
         The centre pieces of the Government’s effort to backstop the        of extreme disruption, but will not unduly stress the
         economy are its wage subsidy scheme and its Business Finance        Government’s balance sheet. The thing to remember,
         Guarantee Scheme. Under the guarantee scheme, banks will            though, is that once Covid-19 has passed businesses will find
         provide loans to businesses but the Government will take 80%        themselves carrying more debt, and will be more focussed
         of the credit risk and the Reserve Bank will provide the funding,   on balance sheet repair than expansion. For example, if the
         if needed, under a newly announced Term Loan Scheme. This is        business loan scheme is fully taken up it would amount to
         almost as though the Crown is lending directly to the business      about 5% of all current business lending (ex agriculture).

01 6 April 2020 Weekly Commentary
In addition to measures to cushion the economy through the        economy now in train, we do expect that inflation will drop to
       Covid-19 disruption, the Government is also looking at policies   low levels over the coming year.
       that will support a recovery in activity and employment
       when the virus has passed. Details of this spending are still     However, it is conceivable that upward pressure on inflation
       being determined. Thus far the Government has signalled its       could emerge over time, for example if permanent disruptions
       intention to significantly ramp up spending on infrastructure     to global supply chains caused higher production costs.
       and building. That comes a top of the $12bn expansion of the      This could eventually force the Reserve Bank to curtail its QE
       Government’s building program which was announced late            program and allow interest rates to rise. In turn, that would
       last year.                                                        hamper the recovery and would make it more difficult for
                                                                         the Government to continue borrowing. We view this as a
       This sort of state-led building program could help to address     risk scenario only, but it does illustrate why inflation will be
       some of the coming increase in unemployment, and it also          important to watch.
       fits with the Government’s aims of refreshing the nation’s
       infrastructure stock. However, we do have some doubts about
                                                                         Operating balance as a % of GDP
       how fast such spending can realistically be rolled out. The
       Government is prioritising projects that will be ‘shovel ready’         % of GDP                                                             % of GDP
                                                                          8                                                                                        8
       within six months and has highlighted that the expected rise in                                                 Actual                  Forecasts
                                                                          6                                                                                        6
       unemployment will ease capacity constraints. But as we have                                                     HYEFU projections
                                                                          4                                                                                        4
       often seen, infrastructure spending can take an extended                                                        Westpac estimate
                                                                          2                                                                                        2
       period to get underway. We suspect that this spending
       will be introduced in conjunction with other measures to           0                                                                                        0

       bolster demand and support the labour market after the             -2                                                                                       -2

       lockdown period.                                                   -4                                                                                       -4
                                                                          -6                                                                                       -6

       The Government’s support packages will be expensive.               -8      Source: The Treasury, Westpac
                                                                                                                                                                   -8
       Automatic fiscal stabilisers will further add to the pressure     -10                                                                                       -10
                                                                            2001        2004        2007          2010    2013       2016    2019    2022
       on the Government’s books, as tax revenue drops and
                                                                                                                      June years
       expenditure in areas like health and social welfare increases.
       We have calculated that the combination of automatic
       stabilisers and the support measures already announced            Net core Crown debt as a % of GDP
       will require the Government to increase its borrowing by
       $65bn over the coming four years. And with further measures             % of GDP                                                             % of GDP
                                                                         60                                                                                        60
       likely to be introduced over the coming months, that figure                                                                                  Forecasts
                                                                                                                   Actual
       will likely rise to around $70bn. That would result in the        50                                                                                        50
       government debt to GDP ratio rising from 18.5% now to 40%                                                   HYEFU projections
                                                                         40                                                                                        40
       by mid-2022. That is high by New Zealand standards, but                                                     Westpac estimate
       still low by international standards and quite manageable at      30                                                                                        30
       today’s low interest rates.
                                                                         20                                                                                        20

       In order to fund this debt, the Government has announced          10                                                                                        10
       that it is issuing $17bn of bonds over the coming three months,          Source: The Treasury, Westpac

       and we estimate that total issuance between now and June           0                                                                                         0
                                                                           1992       1996        2000          2004      2008      2012    2016    2020        2024
       2021 will have to be $48bn.                                                                                     June years

       That is an awful lot of bonds for the market to swallow, but
       fortunately there is a ready buyer. The RBNZ has committed
       to buying $30bn worth of Government bonds over the
       coming year under its Large Scale Asset Purchase Program
       (i.e. Quantitative easing). The purpose of this program is to
       prevent an unwanted increase in interest rates. We believe
       that the RBNZ is aiming to keep longer-term Government
       bond rates at roughly 1%. In order to achieve that the RBNZ is
       probably going to have to increase its program beyond $30bn,
       as well as stepping up the weekly pace of purchases (currently
       running at $1.35bn).

       This raises the question of how long the RBNZ can continue
       to print cash to support increases in Crown spending? The
       key consideration on this front is the RBNZ’s inflation target.
       Provided inflation remains low, the RBNZ can continue with
       asset purchases. And with a significant downturn in the

02 6 April 2020 Weekly Commentary
The week ahead.

       NZ Q1 Survey of Business Opinion                                               QSBO domestic trading activity and GDP
       Apr 7, General business situation, Last: -26                                            %                                                                          %
       Domestic trading activity (past 3 months), Last: -11                           50                                                                                       3
                                                                                      40
       – This quarter’s survey includes responses up to 20 March. While that                                                                                                   2
         predates the country’s shift to Level 4 COVID-19 restrictions, it still      30
         captures much of the recent disruptions to economic activity and related     20
                                                                                                                                                                               1
         changes in business sentiment.                                               10

       – Consistent with other recent surveys, we expect the March quarter survey      0                                                                                       0
         will show a sharp drop in business confidence. We also expect a drop in      -10
         the backwards looking trading activity questions, which tend to be a good                                                           Domestic trading activity,        -1
                                                                                      -20
                                                                                                                                             next 3 months (lhs)
         gauge of quarterly GDP growth. Weakness is expected to be widespread,        -30
         but especially pronounced in the manufacturing sector.                                                                              Quarterly GDP growth              -2
                                                                                      -40       Sources: NZIER, Stats NZ                     (rhs)
       – We will also be watching the hiring and investment gauges, which             -50                                                                                     -3
         are expected to record sizeable drops in the face of a deteriorating            1999          2002         2005         2008     2011     2014        2017       2020
         economic outlook.

       NZ Apr ANZ business confidence                                                 NZ business confidence
       8 Apr, Last: -63.5                                                                      net %                                                                      %
                                                                                      100                                                                                     5.0
       – Business confidence has plummeted in the face of the Covid-19 outbreak                           Business confidence (left axis)
         and the related disruptions to economic activity. The number of               80                                                                                     4.5
         businesses expecting weaker trading conditions over the coming year                              Inflation expectations (right axis)                                 4.0
                                                                                       60
         has dropped to a multi-decade low. Against this backdrop there has                                                                                                   3.5
                                                                                       40
         been a sharp drop in the number of businesses planning to take on new                                                                                                3.0
         staff or undertake capital expenditure over the coming year. The fall in      20
                                                                                                                                                                              2.5
         confidence has been broad based.                                                  0
                                                                                                                                                                              2.0
       – A preliminary result for the April survey will be released this week. This   -20
                                                                                                                                                                              1.5
         survey will cover the first week of the lock down. The activity gauges       -40                                                                                     1.0
         will certainly be weak. We’ll be watching to see how plans for hiring
                                                                                      -60                                                                                     0.5
         and investment are being affected in the face of both the lockdown and                  Source: ANZ
         Government support packages.                                                 -80                                                                                     0.0
                                                                                         2001 2003 2005 2007 2009 2011 2013 2015 2017 2019

       Aus Feb trade balance, AUDbn                                                   Aus trade balance
       Apr 7, Last: 5.2, WBC f/c: 3.5                                                          AUDbn                                                             AUDbn
       Mkt f/c: 3.8, Range: 0.7 to 4.5                                                46
                                                                                                                                                                               8
       – Our forecast is for the trade surplus to narrow to $3.5bn in February, led   42                                   Trade balance (rhs)                                 7
                                                                                                                           Exports (lhs)                                       6
         lower by exports. However, there is extreme uncertainty around this          38
                                                                                                                           Imports (lhs)                                       5
         forecast. Both exports and imports could move in a very large range.                                                                                                  4
                                                                                      34
                                                                                                                                                                               3
       – On February 2, Australia closed its borders to flights from China for non-
                                                                                      30                                                                                       2
         residents. China was in lock-down in February, triggering a collapse in                                                                                               1
         output. Australia sources 25% of goods imports from China - so this is a     26                                                                                       0
         significant disruption.                                                                                                                                               -1
                                                                                      22                                                                                       -2
       – Domestically, exports were also dented by weather disruptions to iron ore                                                                                             -3
         shipments.                                                                   18
                                                                                               Sources: ABS, Westpac Economics                                                 -4
                                                                                      14                                                                                       -5
                                                                                       Jan-10             Jan-12            Jan-14       Jan-16       Jan-18          Jan-20

03 6 April 2020 Weekly Commentary
The week ahead.

       Aus Apr RBA policy decision                                                       RBA cash rate and 3 year bonds
       Apr 7, Last: 0.25%, WBC f/c: 0.25%                                                     %                                                                                %
       Mkt f/c: 0.25%, Range: 0.25% to 0.25%                                             8
                                                                                                                                                                     monthly
                                                                                                                                                                                    8

       – The RBA cut the cash rate by 25bps at its March meeting and by another          7                                                                                          7
                                                                                                                                    RBA cash rate           3 year bonds
         25bps to 0.25% at an emergency inter-meeting move on March 19 that              6                                                                                          6
         also included the deployment of a range of QE measures including
         policies aimed at lowering key market rates (3yr bonds) and providing           5                                                                                          5
         low cost term funding for banks. The RBA has also moved to provide large        4                                                                                          4
         liquidity injections to stabilise increasingly dislocated financial markets.
                                                                                         3                                                                                          3
       – With the RBA continuing to rule out negative rates, the cash rate is set to
         remain at its current level for a very long time. As such, the focus of RBA     2                                                                                          2
         meetings will be on how the Board assesses its QE measures and whether          1                                                                                          1
         they may require adjusting. For April we do not anticipate this requiring            Sources: RBA, Bloomberg, Westpac Economics

         any adjustments.                                                                0                                                                                          0
                                                                                         Mar-06     Mar-08      Mar-10       Mar-12         Mar-14     Mar-16   Mar-18     Mar-20

       Aus Feb housing finance approvals                                                 Aus housing finance by segment
       Apr 8, Last: 4.6%, WBC f/c: 1.5%
                                                                                              $bn                        value of housing finance                            $bn
       – Australia's housing market had started the year with good momentum              14                                                                                         14
                                                                                                    'upgraders'
         ahead of the coronavirus shock, with prices posting solid gains in the first                                      Source: ABS, Westpac Economics
                                                                                                                                                                 since May
                                                                                         12         investor                                                                        12
         few months and turnover holding on to the strong gains in late last year,                  foreign buyers*
                                                                                                                           *based on annual FIRB
                                                                                                                                                                         +29%
                                                                                                                           approvals, financial
         Q1 sales up 28% on the same time last year. In terms of housing finance         10         FHBs                   years (latest is 2017-18)                                10
         approvals, Jan showed a robust broad-based gain, the total value of
         approvals surging 4.6%mth with gains in both volumes and average loan            8                                                                                         8
         size, and across all segments, albeit with investor activity continuing                                                                                         +22%
                                                                                          6                                                                                         6
         to lag.
                                                                                                                                                                         +34%
                                                                                          4                                                                                         4
       – We expect Feb to show a similar pattern with a more moderate pace, the
         total value of approvals rising a further 1.5%. This is ahead of what will be    2                                                                                         2
         a steep drop through March and April as the sector moves into a virus-
         related shutdown. The outright ban on physical auctions and open homes          0                                                                                          0
         that came into effect in late March coupled with wider social distancing        Jan-00        Jan-04           Jan-08             Jan-12      Jan-16      Jan-20
         requirements and health concerns and a deep shock to economic activity
         mean property market activity will be reduced to a trickle of online and
         private sales.

04 6 April 2020 Weekly Commentary
New Zealand forecasts.
        Economic forecasts                                                          Quarterly                                                        Annual
                                                               2019          2020
        % change                                              Dec (a)        Mar              Jun                 Sep         2018           2019              2020f         2021f
        GDP (Production)                                       0.5           -1.0             -14.0               9.9          3.2            2.3              -5.6            6.7
        Employment                                             0.0           -0.9             -6.8                3.6          1.9            1.0              -2.4            3.6
        Unemployment Rate % s.a.                               4.0            4.7               9.0               8.0          4.3            4.0               7.0            5.6
        CPI                                                    0.5            0.5               0.4               0.9          1.9            1.9               2.3            1.0
        Current Account Balance % of GDP                       -3.0          -3.0             -3.5                -3.7        -3.8            -3.0              -4.1          -3.3

        Financial forecasts                                     Jun-20               Sep-20                  Dec-20            Mar-21                 Jun-21               Sep-21
        Cash                                                     0.25                 0.25                    0.25              0.25                   0.25                 0.25
        90 Day bill                                              0.40                 0.40                    0.40              0.40                   0.40                 0.40
        2 Year Swap                                              0.60                 0.60                    0.60              0.65                   0.70                 0.80
        5 Year Swap                                              0.70                 0.75                    0.80              0.90                   1.00                 1.10
        10 Year Bond                                             1.00                 1.00                    1.00              1.05                   1.10                 1.20
        NZD/USD                                                  0.60                 0.62                    0.64              0.65                   0.65                 0.66
        NZD/AUD                                                  0.97                 0.97                    0.96              0.96                   0.96                 0.95
        NZD/JPY                                                  64.2                 65.1                    67.8              69.6                   69.6                 70.7
        NZD/EUR                                                  0.56                 0.58                    0.60              0.61                   0.61                 0.61
        NZD/GBP                                                  0.49                 0.50                    0.52              0.52                   0.52                 0.52
        TWI                                                       67.8                69.3                    70.7              71.4                   71.2                 71.2

       2 year swap and 90 day bank bills                                                          NZD/USD and NZD/AUD
       2.00                                                                         2.00              0.70                                                                           1.00

       1.80                              90 day bank bill (left axis)               1.80
                                                                                                      0.68                                                                           0.98
       1.60                              2 year swap (right axis)                   1.60
                                                                                                      0.66
                                                                                                                                                                                     0.96
       1.40                                                                         1.40
                                                                                                      0.64
       1.20                                                                         1.20                                                                                             0.94
                                                                                                      0.62
       1.00                                                                         1.00
                                                                                                                                                                                     0.92
                                                                                                      0.60
       0.80                                                                         0.80                                             NZD/USD (left axis)
                                                                                                      0.58                                                                           0.90
       0.60                                                                         0.60                                             NZD/AUD (right axis)

       0.40                                                                       0.40                0.56                                                                         0.88
          Apr-19      Jun-19   Aug-19    Oct-19      Dec-19      Feb-20     Apr-20                       Apr 19      Jun 19   Aug 19     Oct 19       Dec 19      Feb 20     Apr 20

       NZ interest rates as at market open on 6 April 2020                                        NZ foreign currency mid-rates as at 6 April 2020

        Interest rates         Current        Two weeks ago           One month ago                   Exchange rates          Current        Two weeks ago             One month ago
        Cash                   0.25%               0.25%                  1.00%                       NZD/USD                 0.5870                 0.5691                0.6334
        30 Days                0.35%               0.43%                  1.00%                       NZD/EUR                 0.5428                 0.5341                0.5582
        60 Days                0.42%               0.55%                  0.91%                       NZD/GBP                 0.4796                 0.4894                0.4853
        90 Days                0.48%               0.67%                  0.83%                       NZD/JPY                  63.62                 63.13                 66.09
        2 Year Swap            0.49%               0.68%                  0.71%                       NZD/AUD                 0.9761                 0.9826                0.9579
        5 Year Swap            0.60%               0.92%                  0.77%                       TWI                      67.85                 66.91                 70.35

05 6 April 2020 Weekly Commentary
Data calendar.
                                                               Market    Westpac
                                                      Last                          Risk/Comment
                                                               median    forecast
        Mon 06
        NZ      Mar ANZ commodity prices             –2.1%          –      –5.0%    Sharp declines across all major commodity exports.
        Aus     Mar MI inflation gauge                1.6%          –          –    A secondary consideration, but below target.
                Mar ANZ job ads                       0.7%          –          –    Hiring freezes should see a sharp pullback.
        Eur     Apr Sentix investor confidence         –17.1        –          –    Confidence evaporated in Mar. Another soft print expected.
        Tue 07
        NZ      QSBO general business situation         –26          –          –   Confidence and trading activity set to fall.
        Aus     RBA policy decision                  0.25%      0.25%      0.25%    Policy rate on hold; QE will be the focus going forward.
                Mar AiG PSI                              47          –          –   COVID-19 disruptions to hit hard.
                Feb trade balance A$bn                5.210      3.750      3.500   Exports and imports to be disrupted by COVID-19.
        Chn     Mar foreign reserves $bn            3106.72    3096.25          –   Little changed despite market volatility.
        US      Feb JOLTS job openings                6963           –          –   Pre-dates COVID-19 shock.
                Feb consumer credit $bn              12.021     13.500          –   Auto loans to come under pressure as COVID-19 shock hits.
        Wed 08
        NZ      GlobalDairyTrade auction result      –3.9%          –          –    Futures markets signal another decline in prices.
                Apr ANZBO business confidence         –63.5         –          –    Early result, covers the first week of the lockdown.
        Aus     Feb housing finance approvals         4.6%       2.5%       1.5%    Market was tracking well ahead of the virus shutdown.
        Thu 09
        Aus     RBA's Financial Stability Review         –          –          –    Six-monthly update comes at a time of exceptional instability.
        UK      Feb trade balance £mn                 4212          –          –    Trade flows to exhibit significant volatility hence.
        US      Mar PPI                             –0.6%       –0.3%          –    Surprised to the downside in Feb.
                Initial jobless claims              6648k           –          –    To be watched closely following two record breaking weeks.
                Feb wholesale inventories           –0.5%           –          –    Final read; prelim showed solid unwinding.
        Fri 10
        NZ, Aus Good Friday                               –          –         –    Public holiday, markets closed.
        Chn     Mar PPI %yr                          –0.4%       –1.3%         –    Upstream prices continue to decline.
                Mar CPI %yr                           5.2%        4.8%         –    Disrupted demand, low oil prices to apply downward pressure.
                Mar foreign direct investment %yr   –25.6%           –         –    FDI flows to drop sharply and remain weak given COVID-19.
                Mar new loans, CNYbn                  905.7     1775.0         –    Credit growth to accelerate in coming months ...
                Mar M2 money supply %yr               8.8%        8.7%         –     ... as authorities encourage economy back to work.
        US      Mar CPI                               0.1%      –0.3%      –0.2%    Expected to fall as demand slows; well below target.

06 6 April 2020 Weekly Commentary
Contact the Westpac economics team.

    Dominick Stephens, Chief Economist                                                                           Paul Clark, Industry Economist
      +64 9 336 5671                                                                                                +64 9 336 5656
    Michael Gordon, Senior Economist                                                                             Any questions email:
       +64 9 336 5670                                                                                              economics@westpac.co.nz
    Satish Ranchhod, Senior Economist
       +64 9 336 5668

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forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The ultimate outcomes may differ substantially from these forecasts.

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Australian Prudential Regulation Authority in Australia. Westpac is authorised in the United Kingdom             the exemption from registration provided by Rule 15a-6 under the Exchange Act and is not subject to
by the Prudential Regulation Authority. Westpac is subject to regulation by the Financial Conduct                all of the independence and disclosure standards applicable to debt research reports prepared for
Authority and limited regulation by the Prudential Regulation Authority. Details about the extent                retail investors in the United States. WCM is the U.S. distributor of this communication and accepts
of our regulation by the Prudential Regulation Authority are available from us on request. Westpac               responsibility for the contents of this communication. All disclaimers set out with respect to Westpac
Europe Limited is a company registered in England (number 05660023) and is authorised by the                     apply equally to WCM. If you would like to speak to someone regarding any security mentioned herein,
Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential              please contact WCM on +1 212 389 1269. All disclaimers set out with respect to Westpac apply equally
Regulation Authority.                                                                                            to WCM.
This communication is being made only to and is directed at (a) persons who have professional                    Investing in any non-U.S. securities or related financial instruments mentioned in this communication
experience in matters relating to investments who fall within Article 19(5) of the Financial Services and        may present certain risks. The securities of non-U.S. issuers may not be registered with, or be subject
Markets Act 2000 (Financial Promotion) Order 2005 (the “Order”) or (b) high net worth entities, and              to the regulations of, the SEC in the United States. Information on such non-U.S. securities or related
other persons to whom it may otherwise lawfully be communicated, falling within Article 49(2)(a) to (d)          financial instruments may be limited. Non-U.S. companies may not subject to audit and reporting
of the Order (all such persons together being referred to as “relevant persons”). Any person who is not          standards and regulatory requirements comparable to those in effect in the United States. The value
a relevant person should not act or rely on this communication or any of its contents. The investments           of any investment or income from any securities or related derivative instruments denominated in
to which this communication relates are only available to and any invitation, offer or agreement to              a currency other than U.S. dollars is subject to exchange rate fluctuations that may have a positive
subscribe, purchase or otherwise acquire such investments will be engaged in only with, relevant                 or adverse effect on the value of or income from such securities or related derivative instruments.
persons. Any person who is not a relevant person should not act or rely upon this communication or
any of its contents. In the same way, the information contained in this communication is intended for            The author of this communication is employed by Westpac and is not registered or qualified as a
“eligible counterparties” and “professional clients” as defined by the rules of the Financial Conduct            research analyst, representative, or associated person under the rules of FINRA, any other U.S. self-
Authority and is not intended for “retail clients”. With this in mind, Westpac expressly prohibits               regulatory organisation, or the laws, rules or regulations of any State. Unless otherwise specifically
you from passing on the information in this communication to any third party. In particular this                 stated, the views expressed herein are solely those of the author and may differ from the information,
communication and, in each case, any copies thereof may not be taken, transmitted or distributed,                views or analysis expressed by Westpac and/or its affiliates.
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