SPEIZER Our view is that New Zealand avoids a recession while recording slow growth – we are not forecasting any more negative quarters over the next couple of years. We expect annual growth to hover around 2 per cent and the OCR to reach 4 per cent in a sequence of two 50 basis-point hikes over the next two meetings, followed by a period on hold.

SMYTH We have a relatively shallow recession pencilled in next year as a base case. Forward-looking indicators, such as business and consumer confidence surveys, are pointing in this direction – which is similar to global indicators. We have the OCR moving to 3.5 per cent – a 50 basis-point increase at the next meeting – and then the RBNZ slowing to 25 basis point hikes for the final two meetings of this year.

There are some upside risks to this forecast but I do not think we are far from market pricing of the OCR right now, which is in the 3.75-4 per cent range. I would say we are in the same postcode – certainly compared with where we have been.

JONES In the short term, there is more work to do – we are forecasting a 3.75 per cent OCR peak. But it is not so much the recession question that is critical for the RBNZ, more the state of the labour market. This will dictate when the reserve bank can afford to ease up on interest rate hikes.

New Zealand raw wage growth is running at about 7 per cent so the risk of a wage-price spiral is real. It is a great time for workers but it means the RBNZ needs to stand guard against second round effects from high inflation.

JONES There are no easy choices for the RBNZ. The inflation picture is such that the reserve bank is having to move in 50 basis point increments – and doing so remains appropriate. The RBNZ has acknowledged the risk that this will ultimately produce a recession.

SMYTH Perhaps a recession is just part of the adjustment process. We have inflation well above target on a headline and core basis. Historically, the way core inflation comes down significantly is via a recession.

How do we define a soft landing? It depends on how we look at it. It could mean avoiding a recession in the next 12-18 months – but what if doing so allowed inflation to become entrenched at a higher level, ultimately requiring a much more elongated tightening cycle? If this is the case, all we are doing with a soft landing is storing a hard one for later. I am not sure I would necessarily call a shallow recession a hard landing.

The RBNZ could stop hiking earlier but inflation is clearly the key impediment. The extent of inflation is the handicap for providing support. To the extent inflation is driven by supply side factors that are out of its control, the RBNZ will require some luck in the sense of some of these factors going into reverse. This could mean global commodity prices or supply chain issues.

On these fronts, we have noted some tentative signs of improvement. The RBNZ cannot stop the war in Ukraine, but if global supply-side factors start improving it would be helpful in alleviating the need for the reserve bank to restrain demand.

SMYTH It is a tough one. Inflation is a lagging indicator, while monetary policy can lag by 12-24 months too. I doubt the RBNZ will consider cutting rates for some time, but if the economy experiences a deep recession it will have to react.

SPEIZER The RBNZ has laid out a soft landing in its MPS [monetary policy statement] in May and August and, so far, it has not been too far off track. Next year will be key.

WHETTON New Zealand is not heading toward a hard landing. Governments around the world have been concentrating on keeping their budgets in surplus in the recent past, and while this changed during the pandemic there is an ability to raise money very quickly.

Should it be needed, the RBNZ can always lower rates. Central banks build a fair bit of runway when they increase rates quickly from an extremely low base, which means they can course correct if needs be.

JONES Our view is that inflation has peaked. We are seeing solid declines in petrol prices, shipping costs and commodities that, if sustained, should start to help inflation ease. Having said this, an easing cycle could be a way down the line yet. The RBNZ will be wary of inflation persistence.

SPEIZER Rates expectations are looking a lot more plausible than they were a few months ago, when peak OCR pricing reached 4.8 per cent. Expectations have fallen by around 100 basis points since and are arguably now a bit too low. Market pricing for the next few policy meetings seem about right – it is close to our own forecast. But into next year, the market is effectively pricing in an easing. We think this is too early.

WHETTON We will be watching the slope of the 1-2 year swap curve after a 50-60 basis point move. Australia, New Zealand, the US, Canada and the UK have dropped from the mid-50s or higher toward flat or inverted. This tells us the market’s view on pricing is tipping toward a recession or at least a slowdown, and therefore forward rates are going lower.

SMYTH The timing of cuts next year is interesting – the market has cuts coming earlier than we think as part of our central forecast. But this is a global phenomenon. The market has priced two cuts from the Fed [US Federal Reserve] next year and it believes the RBNZ is quite advanced in its tightening cycle, showing more visible signs of weakness in growth indicators than many countries. It therefore thinks the RBNZ will likely be one of the first central banks to start cutting rates.

Looking back on the last five US tightening cycles, there was – on average – seven or eight months between the last hike and the first cut. This is essentially what the market is pricing in this time around in the US. If the market has this priced in for the US it makes sense that it will have a similar view on New Zealand.

The question becomes whether central banks will be quick to cut when the necessity emerges. Inflation will be much higher this time and the risk is the Fed takes longer. The same will likely be the case in New Zealand.

SMYTH From the RBNZ’s perspective, the housing market was priced at an unsustainable level. It also thinks inflation is too high and the labour market too strong. At the moment, everything is pointing in the same direction – which is the need to tighten monetary policy.

The return of the house prices and employment to a more sustainable level will hopefully help reduce inflation. For the RBNZ, a slowdown in the housing market would be part of the necessary adjustment process it wants as part of its core mandate. A big chunk of local inflation is related to the housing market and construction costs. A slowdown in the housing market that alleviated some inflationary pressure would help the RBNZ meet its core economic mandate.

A major crash would likely be a game changer, but so far house price falls are part of the necessary adjustment process rather than something that would lead the reserve bank to change tactics rapidly.

SPEIZER Housing is the intended and primary channel for monetary policy to have an effect and the impact on housing so far is what we, and the RBNZ, expected. We forecast a 15 per cent retreat in housing and so far it has retraced about 10 per cent. We expect another 5 per cent to go. It is important to remember that, in net terms, homeowners are still ahead over the past few years.

JONES The RBNZ’s biggest challenge will be judging the persistence of inflation – which will be difficult given domestic and global uncertainty, and the lags involved. Our research suggests the risk is that inflation proves more persistent than the central bank is currently allowing for, which could mean elevated rates for longer than markets currently expect.

The housing market is obviously a factor in the RBNZ’s decision-making but it is not the primary objective. Inflation and the labour market remain the key objectives for setting monetary policy. It is worth bearing in mind, too, that the housing market downturn is largely by design.

The correction has been fairly orderly so far, particularly if we consider how fast house prices went up in New Zealand and how stretched they got relative to fundamentals. They have fallen by about 8 per cent from the peak over a period of about 6-7 months. The RBNZ will not be fazed as long as the drawdown remains orderly.

JONES There have been some questions about how hard and how fast tightening could progress, given the housing market is starting to wobble. But the RBNZ has its labour and inflation objectives to meet first and foremost and, to its credit, retains a laser-like focus on those.

I think the optics of symmetry are also important. The RBNZ did not respond via monetary policy when the housing market was booming, and we are now seeing the flipside of this. Having said this, if the correction became disorderly all bets would be off.

JONES They are starting to bite. We have done analysis on whether households can handle mortgage increases. The results suggest the net impact of higher mortgage rates over the next 18 months is about a NZ$5 billion (US$3.2 billion) addition to household outgoings. But when we add in all the other cost of living impacts – food, petrol, rent and so forth – this estimate rises to about NZ$15 billion. That is a material number, equivalent to around 9 per cent of annual retail sales.

It explains why we are seeing consumer sentiment at recessionary levels. After the party comes the hangover. Households will pay their mortgages, particularly when everyone has a job and wage growth is strong – we are not seeing mortgage distress, in other words. But discretionary spending is going to come under real pressure. We expect consumer spending to slow to a crawl over the next 12 months.

JONES The labour market is critical. The latest labour market statistics show employment in New Zealand has started to hit a wall. We have seen very little new employment growth over the last three quarters but a very clear acceleration in wages. There is just no-one left to hire so firms are poaching people in existing employment and bidding up wages.

It may be that unemployment is about as low as it can get in New Zealand. This will concern the reserve bank as it could be the beginning of the dreaded wage-price cycle. It reinforces the fact that the RBNZ cannot afford to ease up just yet.

On migration, our forecast shows positive net inflows will not be recorded until the end of 2023. We suspect this development, when it occurs, will be key to easing pressure in the labour market and hence on wages and inflation.

WHETTON Japanese investors do not feature as prominently in New Zealand as they do for Australian dollar bonds. This is largely due to Japanese investors not being offered New Zealand dollar instruments. The recently issued 30-year New Zealand government bond [NZGB] is a good indicator of international interest – it was largely bought by US investors.

I do not anticipate the investor makeup changing. Hedge costs for New Zealand dollar assets have been quite punitive from a yen perspective recently, so Japanese investors were never going to be big net buyers. In fact, these investors were selling Australian dollar assets earlier this year. They do not have portfolios aimed at New Zealand dollars.

SPEIZER International participation in sovereign, LGFA [Local Government Finance Authority] and Kāinga Ora – Homes and Communities bonds has been steadily rising for about the last 6-12 months.

Anecdotally, we have not picked up any indications that New Zealand is falling off the radar. If anything, New Zealand being earlier in the tightening cycle suggests it will peak earlier, which means it should attract investors that eventually shift to a long from a short duration stance.

WHETTON We are noting substantial increases to New Zealand dollar holdings internationally because of where the country’s rates sit within the G10 structure – they are much higher, which has encouraged international investors to take the additional yield.

The addition of New Zealand bonds to the MSCI index later this year has further augmented demand. Index inclusion will encourage wider holdings of New Zealand bonds across the world.

One of the biggest impediments, though, is the perception among international investors that the New Zealand market can be difficult to exit during times of high volatility. But we think this will change over time as the market becomes deeper, which will bring greater international participation.

SPEIZER Inflation-indexed NZGBs entered the FTSE World Inflation-linked Securities Index in April, and in November nominals will enter the FTSE World Government Bond Index. This should be positive for the breadth of participation in NZGBs, which in turn will improve demand and liquidity. However, sometimes these things are hard to observe and we expect it to be a slow burn effect.

SMYTH The recent World Bank deal printed well inside where the issuer would have priced in US dollars, so New Zealand dollar is relatively attractive for issuers. The issue with Q2, besides the seasonality, was the enormous sell-off in bond markets – volatility was exceptionally high, which meant judging demand and executing transactions was more tricky than usual.

SMYTH The inclusion will drive two trends. One will be a concentrated demand impulse, which will occur around the month end when the bonds enter. Passive funds that did not previously own New Zealand bonds will now own them, which will generate demand that comes near the event itself at the start of November.

Next, as Imre Speizer and Martin Whetton point out, it will raise the broader profile of New Zealand dollar bonds with global investors. A number of active investors hold New Zealand assets off benchmark anyway, but some active investors that have not bought will do so now these bonds are part of a benchmark. Over time, some might seek to optimise New Zealand benchmark exposure by purchasing NZGBs, LGFA and Kāinga Ora bonds, or Kauris. These are second round effects that will all be positive directionally. But I do not think they will happen from day one.

We expect NZGB demand to increase later this year, going on what has happened to other countries that have joined the index. Offshore holdings in these cases – which typically were a lot lower than New Zealand’s currently are – trended up over the years following addition to global indices.

SMYTH The recent World Bank deal printed well inside where the issuer would have priced in US dollars, so New Zealand dollar is relatively attractive for issuers. The issue with Q2, besides the seasonality, was the enormous sell-off in bond markets – volatility was exceptionally high, which meant judging demand and executing transactions was more tricky than usual.

SMYTH New Zealand Debt Management [NZDM] is doing a good job of being transparent and communicating. There has been a lot of buying from offshore over the past 12-18 months. We have had large flows into the market, which could suggest investors might be getting more confident. Index inclusion will also be good for the market’s profile – we will see a halo effect.

There have been instances, such as in early 2020, in which markets stalled, offshore investors found it difficult to sell out of their positions and the RBNZ came to the rescue. But this was not just a New Zealand phenomenon – it happened everywhere. Quality has deteriorated in all markets,but arguably NZGBs have held up better than sovereigns elsewhere.

SPEIZER Dysfunction in bond markets is a global story – on occasion it has even been experienced in US Treasuries. New Zealand is subject to similar dynamics as those affecting global markets, but the effect can be even more acute given it is a smaller market.

NZDM has adopted a dynamic and flexible approach to issuance to assist market functioning, for example issuing linkers in the weekly tender dependent on demand at the time. This approach is welcome.

WHETTON A lot of issuers are adapting their programmes to give end investors what they want. They are being more dynamic on duration, for example. The LGFA reduced duration to shorter-dated bonds in its regular monthly issuance at a time when the market simply did not want duration. As a result, LGFA was able to get absolute dollar volume away and allow the market to continue functioning very well. This approach filtered to NZDM: it is working very closely with investors in a sensible way that is holding it in good stead.

On the other hand, these New Zealand issuers do not have the flexibility to switch format to floating-rate notes [FRNs]. This is something the semi-government issuers in Australia can do, knowing 30-40 per cent of their buyer base is balance sheets that want floating-rate format. But New Zealand issuers have worked well within their limitations.

SPEIZER Shortening the duration of weekly NZGB tenders has had a noticeable effect on tender metrics and longer duration bonds have performed much better since the change. FRN issuance in the high-grade space is uncommon, but it does occur in other grades – we have seen some corporates successfully issuing FRNs.

WHETTON It is possible but we need to consider the context of how much volume the Australian semi-governments actually do. They have issued in euro and up and down the curve as a means of getting the volume they require.

New Zealand issuers come from a smaller programmatic requirement and a smaller market, so they will be reluctant to surprise with something unusual that would dilute regular and predictable issuance. Also, if they take away from the regular programme, what they would be doing is essentially favouring one investor over another. This could create an environment where they might put regular investors offside just to save a couple of basis points.

SMYTH Not really. The RBNZ announced its intentions in February and it was pretty clear then that it was going to be NZ$5 billion per year, starting in the middle of the year. NZDM incorporated the LSAP sales in its funding projections at budget and this has led to a higher issuance run rate since July. The market has been aware of this for some time, in other words.

The RBNZ is selling the bonds back to NZDM, so it is not happening on the secondary market. This is a good thing, because we would have had problems with two issuers trying to sell bonds in the same week.

The RBNZ is selling its long bonds first – this is part of the process. By selling back to the NZDM, it is not creating more duration needs for the market. Swap spreads in the 10-year space are trading toward the low end of the range, which is consistent with a somewhat higher run rate for issuance from July.

Where there will be an impact is on the Bloomberg New Zealand bond index. By selling longer-dated bonds first, the RBNZ will shorten the benchmark, all else being equal – or at least the benchmark will extend less than it would otherwise. This will reduce end of month demand from real-money accounts, again all else being equal. But we view this as is a second-order impact.

SMYTH The reserve bank went about it sensibly. The question was whether to sell assets or let them mature. Different central banks took different routes: for example, the RBA [Reserve Bank of Australia] is going to hold until maturity and the Fed is doing the same – though it has multiple bond maturities every month so its balance sheet runs down quite quickly.

The RBNZ has chunky bond maturities with the first one in the middle of 2023. It would take a take a very long time to let them all mature. The reality is, if the reserve bank waited for them to mature something could easily happen in the interim – there might be another crisis – and the balance sheet would never stand a chance of normalising.

WHETTON The only other way the RBNZ could have managed a sell-down is through reverse tenders, particularly as bonds have traded so rich to swap in the front end and there is clearly a need for balance sheets to buy these bonds. Following this approach would have increased the free flow of bonds and added liquidity.

SPEIZER One clever feature of the unwind is the independence of the maturity profile of the reissuance, or refinancing, from the bonds NZDM is buying from the RBNZ. Without this feature, the market could assume like-for-like reissuance and, given the RBNZ has stated it is selling the longest maturities first, long durations would suffer the worst. The introduction of this feature has certainly calmed the market and, so far, QT effects do not appear to be significant.

SPEIZER This has distorted pockets of the market and everyone is aware these distortions will not fade until the QT programme has ended – which is almost five years from now. It most obviously distorts short-dated FX swaps, which are frequently used by on- and offshore participants to park money.

New Zealand interest rates, as implied by FX swaps, have been well below where they should be since the ESA cash balance has grown. However, the RBNZ has tried to mitigate this distortion by introducing a new standing facility, where institutions that can ot – as banks can – leave their cash with the RBNZ at the OCR can park their money at OCR minus 15 basis points. This is much higher than the rates implied by FX swaps.

WHETTON The ground has already been readied by other issuers, such as global SSA [supranational, sovereign and agency] borrowers and Kāinga Ora. But the Asia-Pacific region has not seen anything from sovereigns just yet, apart from Singapore just recently. New Zealand’s green bond will thus be a new and exciting development, and it is noteworthy that it will be issued before Australia – at sovereign level – does anything in this market.

I think what is important is that sovereign borrowers – and not just New Zealand – have consistent issuance rather than one-offs. This is key as regular supply will build investor acceptance and comfort. I would like to see an NZDM deal every year, which is the way the UK and Germany have done it, and Canada plans to.

SMYTH NZDM will be a frequent issuer of green bonds. The market is growing fast but bringing the government into play will help it gain critical mass in future. Green bonds are also good for New Zealand’s global profile. Sustainable, green investors and green-bond funds that might not have looked at New Zealand previously, because it is a small market on the other side of the world, might start taking notice. It can only be a positive development for the market.

SMYTH It definitely legitimises the whole concept and creates a halo effect. In general, this is a path we are on and the sovereign joining is part of the trend. Greater corporate issuance will be part of the journey.

SPEIZER The funding implications of some of these reforms, such as Three Waters, are not yet clear. Once they are, we expect much of the associated debt funding to be in green format. Such green debt supply will be into a market that has good demand for the asset class.

WHETTON There will be robust demand: if you build it, they will come. When supply comes, the market will find the clearing price and provide the demand. Regulators may eventually require investors to have a certain percentage of high grade assets on their balance sheets, which should drive ongoing demand. But, for now, the growing desire from bond managers to find assets for their environmental, social and governance (ESG) portfolios will provide a solid backdrop.

SMYTH Interest rates are going up significantly, which makes investing in fixed income look more attractive to retail investors. There is still a lot of cash in the banking system so term deposit rates have remained relatively low compared with corporate bond issues, which only adds to the appeal. For retail investors, it has looked like a relatively attractive place to park money.

Lately, term deposit rates have been increasing and wholesale rates have come off their highs, so the differential has narrowed significantly. I would caution against expecting a continuation of the pace of demand we saw in the last quarter.