First View - Fonterra delivers a Butter than expected payout

Fonterra delivers a Butter than expected payout. But petrol prices are hurting.

• We have released our 2018-20 outlook. We are rather upbeat, but wary of the risks.
• Fonterra lifted it’s 2018/19 payout forecast to $7. If they are not profitable at $7, they’re not viable.
• Petrol prices are already hurting, and Aucklanders face another kick at the pump.

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Data wrap
Last week we released our NZ economic outlook report. The outlook is fine and partly cloudy. The land of the long white cloud is surrounded by low weather patterns. Hopefully they dissipate. Our forecasts show an economy growing a little above trend into next year. Slightly above trend growth should lead to a slightly faster reduction in spare capacity. The global backdrop is conducive to strengthening price pressure, with solid demand. The missing piece of the economic puzzle, inflation, should be found in time. Once found, the RBNZ will begin to lift interest rates. They will take their foot off the economic accelerator and start normalising policy. So the message is clear, don’t fear rampant inflation or rapidly rising interest rates. But both will rise in coming years. This is good news.

The good news also came in a butterful update from Fonterra. Fonterra put out a bullish first up forecast for the upcoming 2018/19 dairy season payout of $7.00/kgms. This comes on the back of recent rise in diary prices, aided by rising demand from China according to Fonterra. They also revised up their expectation of the current season payout by 20 cent to $6.75/kgms. The higher payouts are likely to be welcome news for dairy farmers that are presently facing some significant challenges. Not least the cattle disease Mycoplasma bovis. The Government is expected to announce later today if it will go ahead with full eradication (culling stock of affected farms) or move to a plan of long-term management of the disease. While production from cattle with the disease is still fine for human consumption, there are long-term economic costs of living with the disease.

There are signs that household spending growth is slowing. Retail sales volumes barely registered a rise over the March quarter, posing a downside risk to GDP growth. Petrol prices hit record highs in parts of the country. And net migration eased further in April, with annual net long-term arrivals falling to 67,000, down from the peak of around 74,000 in July last year. Long-term non-NZ citizen departures have picked up, as visas expire. Net migration still remains elevated by NZ history and continues to support GDP growth, just less than 2017.

Chart of the week: Outlook is fine and partly cloudy
We provide a suite of forecasts out two years. The highlights in the first table, are detailed are in the last table. Growth of around 2.9% yoy this year will hopefully be followed by above trend growth of 3.5% yoy early next year. Inflation will strengthen from 1.1%yoy today, to 2.1% yoy this time next year. Stronger headline inflation, along with hikes in the minimum wage rate, will enable a healthy lift in wage inflation to 2.5% by the end of next year. All going well, we expect the RBNZ to be in a position to lift interest rates at the August MPS. The Kiwi interest rate curve will move well in advance, and flatten aggressively into RBNZ hikes. The Kiwi dollar is likely to remain on a downward path, until the RBNZ moves to a hawkish bias (early in 2019). The outlook is good, but not yet great. And there are risks.

In terms of risks, most of these are foreign. Despite recent developments moving toward resolution on trade between the US and China, we aren’t there yet. Trade wars don’t end well. And New Zealand is now more exposed to an Asian slowdown than ever before. Another risk is the end of the great financial experiment. Central banks around the globe will move, slowly, to unwind ultra-accommodative monetary policy. Financial markets are likely to become more volatile, and may react adversely to the draining of stimulus. And then there are the banks. A tightening in financial market conditions may lead to a significant rise in bank funding costs.

Financial markets
Markets exhibited risk-off behaviour last week, buying gold, yen, and high quality government bonds. This move was in part due to the on-again, off-again, and possibly on-again denuclearisation summit between the US and North Korea. There remains a faint hope of that the summit will go ahead following surprise talks between both North and South Korean leaders over the weekend. But there is something that feels a bit too good to be true about this huge 180° turn in attitude from North Korea. Adding to general risk aversion was heightened political uncertainty in the Eurozone.

A cloud hangs over Italian politics, with the likely formation of a government consisting of two main populist parties – Five-star movement, and the far-right League party. The new Government is expected to pick a few fights with the European Union on fiscal austerity. Sticking with southern Europe, Spain may be pushed into a snap election after the country’s main opposition party called on a vote of no confidence in the government. Both Italian and Spanish 10-year government bond yields lifted. In contrast, increased demand for high quality government bonds led to a fall in yields of long-dated US, UK, Japanese and German debt. The benchmark US 10-year treasury yield closed the week at 2.93%. The euro fell against the US dollar, and European equity markets took a hiding.

Oil prices closed the week sharply lower, and follow 3½-year highs hit early in the week. The West Texas Intermediate (WTI) price closed the week just shy of US$68/barrel as Russia and OPEC signalled they would plug the supply gap left by Iran and Venezuela.

Foreign exchange
The USD has had a strong run recently. But momentum in the world’s reserve currency is cooling. In terms of levels, the USD (DXY) remains well below the 2015-16 highs. There is still room to move. The Kiwi is oscillating around a cent range with $0.6900 proving to be an equilibrium point in the short term. With multiple risks back on the radar from the global community and unflattering data expected domestically via the RBNZ Financial Stability Report and the Terms of Trade, expect the NZD to struggle to push meaningfully higher. With so many risks around and global yields falling the benchmark US 10-year yield is now below 3.00% which has taken the USD lower with it. However, this has not lead to NZD/USD strength given the generalised risk off tone cloaking markets. .

Interest rates
The curve has flattened as global yields retrace from the highs on multiple geopolitical risks. Short-end yields continue to find good support, with the 2-year swap finding good pay side support below 2.20%, and equally good receive side around the 2.25% level. NZ long-end yields have fallen with the US 10-year yield needing to consolidate above 3.00% in order to confirm the break and thus a steeper curve, that is yet to occur with the emphasis now on the raft of US data and soothing of geopolitics risks.

Upcoming Events – Domestic

Apr Building Consents (Wednesday)
Last: 14.7% mom
Residential building consents jumped 14.7% mom in March, thanks to a lift in Auckland apartments – a volatile series. The pick-up in consents of recent months merely provides a distraction to the fact that residential consents are only gradually above levels seen in late 2017. Capacity constraints faced by the construction sector are likely to limit the extent that consents can lift from here.

May RBNZ Financial Stability Report (Wednesday)
We have the RBNZ’s semi-annual Financial Stability Report (FSR) on Wednesday to look forward to. The May FSR is overshadowed by the Australian Royal Commission into misconduct in the banking industry. Some banks in Australia have not been playing nicely and there are some concerns that this maybe the case here. We expect there to be some response to this by the RBNZ in the FSR. The main development at the last FSR back in November was the RBNZ’s decision to loosen Loan-to-value ratio (LVR) restrictions on both residential and investor lending. We don’t expect any changes to macro-prudential policy this week. There was little mention of macro-prudential policy from Adrian Orr at the Bank’s recent Monetary Policy Statement (MPS). Moreover, there is unlikely to be much appetite from the RBNZ to stoke a resurgence in credit growth given the gradual recovery seen in house price appreciation over the last few months. Key themes of the FSR are likely to remain the high levels of indebtedness of households and the dairy sector. The latter faces the added risk of the current Mycoplasma bovis scare. The RBNZ is also likely to note the recent tightening in global financial market conditions following the rise in LIBOR/OIS spreads in the US. .

May ANZ Business Outlook Survey (Thursday)
Monthly balance – Last: -$86mn; Consensus: $198mn
Business confidence has been surprisingly subdued in recent months, with the hangover from a change in government lingering much longer than expected. The ANZ-Roy Morgan Business Outlook survey in April recorded a dip in firms’ outlook for their own activity – led by a sharp fall in the construction sector. A net 17.8% of businesses expect a rise in their own activity over the coming year, down from a net 22% the month prior and a net 43% in June last year. Capacity constraints in the construction sector look to be playing a role here, holding back investment and hiring decisions. However, this pessimism may not last. The BusinessNZ Performance of Manufacturing (PMI) index jumped almost 6 points in April to a reading of 58.9 – indicative of decent pace of growth in the month.

Mar Qtr Terms of Trade Index (Friday)
Last: 0.8% qoq; Consensus: -2.0% qoq
NZ’s merchandise Terms of Trade (ToT), an indicator of our purchasing power with the rest of the world, reached another recorded high in the December 2017 quarter. The 0.8% qoq rise was supported by solid increases in the prices of many key export commodities such as meat and dairy (in particular butter and cheese). The price of imports also lifted in the quarter but by a lesser extent. Since the start of the year commodity prices have consolidated on recent gains. However, key import prices have posted some decent gains, in particular oil. We may see the first fall in NZ’s ToT in the March quarter since the September quarter of 2016. The market is picking a 2% qoq fall. Nevertheless, NZ’s ToT is expected to remain elevated for the foreseeable future, one factor we believe will help lift in GDP growth over 2018.

Upcoming Events - International

• Australia: Private Sector Capex
• China: Official and Caixin Manufacturing PMIs
• Japan: Unemployment rate, Industrial production
• United States: Non-Farm Payrolls, Consumer Confidence, Fed Beige Book, PCE Deflator
• Eurozone: CPI
For event details, please view the PDF report.
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