It Is Worth Considering 50bp Rate Cuts. The Fed Did It. And The Kiwi Economy Is In Worse Shape.

• Volatility in financial markets was surprisingly well-contained last week. And that’s despite the Fed kickstarting its long-awaited cutting cycle with an outsized 50bps cut. Odds of a soft landing have increased for the US economy.
• The RBNZ, in contrast, will have to deliver more rate relief than the Fed with the Kiwi economy in a fragile state. Economic output contracted once again in the June quarter. And we’ve been in a per capita recession for the past two years.
• Monetary policy has done enough to free up spare capacity and restrain inflationary pressures. Enough is enough. A rate cut in October is as close to a done deal as you expect.

Here’s our take on current events

Last week was jam-packed with data releases and central bank rate decisions. And the most important of all was the big, bold 50bps cut from the US Federal Reserve – shifting the federal funds rate to a range of 4.75% and 5%. Take it as a sign that the Fed is serious about removing the chokehold on the US economy. But it’s hats off to the Fed for delivering an outsized move without causing mass hysteria in the markets. In fact, risk appetite improved in the days following the announcement. Equities rallied and the VIX – a measure of volatility in financial markets – actually declined. Not exactly the outcome we were bracing ourselves for going into last week’s events. As reflected by a lift in the US 10-year Treasury yield, investors are feeling confident about the growth outlook. The Fed’s updated projections still paint a rosy outlook, with unemployment peaking just 0.2%pts above the current rate of 4.2% and the economy growing above trend through to 2027.

The new dot plot signals another 50bps of easing this year, with two meetings remaining, and 100bps of easing in 2025. Odds of a soft landing have increased now that the Fed is chartering a course back to neutral policy settings. Where the neutral rate lies, however, is still anyone’s (educated) guess. Fed officials can’t quite agree. The median projection of the long-run neutral rate rose to 2.9%, but the spread of forecasts ranged from 2.4% to 3.8%. We would argue it is around 2.5-to-3%. And that’s still a big drop from the 5.5%, very restrictive, peak. Relief is coming.

For the RBNZ, we’re expecting another 50bps of cuts by year-end, like the Fed. But we think the RBNZ will need to do more than the Fed next year, as the Kiwi economy requires more rate relief. Economic output has contracted in five of the last seven quarters. And it was the 0.2% decline over the June quarter that was the latest to add to the tally. The fall of -0.2% was not as deep as the -0.4% that majority of forecasters were expecting. But it’s still a fall. RBNZ had forecast a fall of -0.5%. But this was revised down from a +0.2% gain in their estimates in May. On a per capita basis, the report is miserable. We’ve seen seven consecutive contractions, with a sizable -0.5% in the June quarter. Activity per head is down 2.7% over the year, and down 4.6% from September 2022 – far worse than the cumulative 4.2% decline during the GFC. There is light at the end of the tunnel, and it’s burning brighter. We think the RBNZ’s decision to cut the cash rate in August, marks the turning point in this cycle.

Our latest economic report card proves that restrictive monetary policy has done enough damage to restrain inflationary pressures. Enough is enough. And the RBNZ are responding – late, but in earnest. A rate cut in October is as close to a done deal as you get. In fact, we’d argue the only discussion should be on delivering 25 or 50. We’d advocate 50. And again, 50 in November. The RBNZ’s first 25bp cut in August marked the start of a move towards 2.5-to-3%. That’s at least 250-to-300bps. We argue the RBNZ needs to get the cash rate below 4%, asap. It takes up to 18 months for rate cuts to filter through the economy. We all love fixed rates. And fixed rates need time to roll off. Effectively, the RBNZ are cutting today for an economy at the end of 2025, the start of 2026. Get moving…

Chart of the Week: C + I + G + (X-M) = GDP

Another way of calculating Gross Domestic Product is by the expenditure approach which combines household consumption (C), business investment (I), government spending (G), and net exports (exports (X) minus imports (M)). And the expenditure measure offered a more encouraging view of the Kiwi economy – but only by a smidgen. Expenditure GDP was flat over the June quarter. Household spending, government spending and business investment were all up over the quarter. But the gains made across these three components were offset by the 0.8% decline in exports. And leading the decline was the 4.4% fall in goods exports. The 1.4% decline in agri production was mirrored by falls in exports of dairy and forestry products.

Household consumption increased 0.4% over the quarter, far stronger than the 2.2% decline the RBNZ had pencilled in. Despite the June quarter jump, private consumption remains weak with the March quarter print significantly downgraded from 1.6% to 0.5%. Mirroring the decline in retail trade on the production side, consumption of durable goods declined a chunky 3.4% over the quarter. And compared to last year, durable spend is down almost 10%! – the fourth straight annual decline. Households are reining in their big-ticket spending as tight financial conditions weigh on wallets. And the rotation away from goods and towards services continues. Consumption on services increased, albeit by a smaller magnitude compared to the start of the year, up 0.8%. Annual services consumption increased 1.3% - the first positive print since September 2022, but still running well below the long-term average.

Beyond households, business investment picked up with a 1.1% over the quarter. Investment in plant and machinery lifted almost 2%. Similarly, the downtrend in building consents has seen a 5.8% decline in residential buildings compared to a year ago. Nonetheless, overall gross fixed capital formation eked out a 0.2% gain over the quarter – the first increase after four quarters in decline.

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