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The shifting sands of 2022

The tide has gone out on mass tourism, and our major trading partner is slowing down. So don’t expect the world to get back to normal now that we have all decided to live with the virus, writes

Dileepa Fonseka.

Wigram Capital Advisors principal Rodney Jones is not a very optimistic guy when it comes to the New Zealand economy these days.

Why is Jones not hopeful? New Zealand may not be a zero-Covid country any more, but after a slow start we have high vaccine coverage, unemployment is low, and the property market is as rocksolid as ever.

And don’t forget this: Our largest city is about to get out of a three-month lockdown.

There is nothing like an influx of post-lockdown spending to really juice up the economy, right?

‘‘I was very optimistic in 2020 because I thought that elimination worked as a strategy,’’ Jones says.

‘‘Today, I’m more pessimistic because I think living with the virus is going to be challenging, and I think our major trading partner won’t be growing fast, and we won’t have tourism.’’

Overly pessimistic, surely? If New Zealand takes a bad turn, the Reserve Bank still has our back with interest rate policies that could cushion the blow, correct? Not so much, according to Fisher Funds head of fixed interest David McLeish.

‘‘What we’re actually pricing right now, in New Zealand interest rate markets, is the fastest and steepest hiking cycle of all time.’’

Jones says New Zealand may well experience in 2022 what other countries have already been through: A major public health crisis in winter, and a community reluctant to return to the office or visit cafes and bars.

In short, a public that does not return to its old spending habits but instead acts much like it did during lockdown, which means lots of online ordering, less spending on services and no speedy return to the heady days of late 2020.

A recent report by the International Monetary Fund seems to back him up. It signals the pandemic-related shift in European spending habits from services to goods continued even after public health restrictions were lifted.

‘‘What we’re finding is that we can’t get back to normal,’’ Jones says.

If this happens in New Zealand it means tough times ahead for the services sector, and more inflation driven by international supply chains that are already struggling to keep up with increased demand for goods.

Jones thinks a lot of people are in denial about this, including the Reserve Bank. It has adopted a stance on interest rates and inflation out of step with our trading partners, signalling steeper rate hikes than much of the rest of the world is currently comfortable with.

While such a rates rise might kill rising inflation, it also might make it harder for the economy to recover by making the cost of capital more expensive.

Jones also doubts inflation will lead to the kind of persistent wage-price spiral seen in the 1970s.

Yes, prices are rising, but he argues wages aren’t rising nearly as fast to keep up.

Jones says the cure for higher prices is sometimes higher prices, meaning demand could shrink when prices finally get too high and inflation could ultimately prove ‘‘transitory’’. In this scenario, an interest rate hike at the same time might just make things worse.

‘‘What we need to react to is a wage-price spiral, right now we just have higher prices.’’

That is why other central banks are largely waiting to see what happens, especially the Reserve Bank of Australia, Jones says.

However, it is also fair to say there is no clear consensus on which of these central bank strategies is likely to work. All of these rate hikes are also subject to change, with the US Federal Reserve having already brought forward its own plans for rate hikes.

Assuming New Zealand continues to lead the pack on interest rate hikes, Jarden managing director and head of FICC Matt Blackwell says this brings with it the prospect of a rising New Zealand dollar in 2022, which could harm the competitiveness of our exports.

It will be a scenario many businesses haven’t seen in a while. Blackwell saw such times right at the beginning of his career. He used to work for the Apple and Pear Marketing Board when it hedged currency three or four years in advance because high interest rates drove up the value of the New Zealand dollar.

‘‘Back in those days, you had a very, very large interest rate differential in New Zealand’s favour.

‘‘New Zealand interest rates were significantly higher, so the forward point discount was significant. So there was a real incentive to hedge forward.

‘‘The risk with hedging is you’re locked into that amount and that rate . . . if the outlook for commodity prices change, and the supply or the demand changes, you could go from a position of being under-hedged to over-hedged and that has a real financial impact.’’

In recent times the currency has not moved around as much. After the global financial crisis central bank policies began to synchronise with one another as everyone cut interest rates, or engaged in quantitative easing, but now they are about to fall out of sync as central banks pursue different strategies.

The Reserve Bank of Australia is ‘‘dovish’’ (keen on keeping interest rates as low as possible in the face of inflation), the US Federal Reserve and the Bank of England less so, other central banks, like Sweden’s, have previously signalled they might look to hold interest rates at zero for four years.

New Zealand’s Reserve Bank is one of the most ‘‘hawkish’’ (keen to cut off inflation by raising interest rates), and Blackwell sees the potential for a divergence in the different interest rates between New Zealand and other economies.

With no currency controls this could stoke the ‘‘carry trade’’ with people borrowing in a low-interest rate currency like the Australian dollar and converting this borrowed currency into New Zealand dollars – thus driving up the value of our currency, and profiting off it.

All of this is contingent on the Reserve Bank following through with its planned rates hikes, and other economies holding to their own plans in the face of rising inflation.

Even if such a divergence takes place, Jones sees a host of factors pushing against New Zealand’s currency floating upwards, the biggest of which is China.

‘‘Like us, they’ve had very high house prices, and an important part of their economy has been the property market, and property construction.

‘‘Xi Jinping has said houses are for living, not for speculation, and they’ve got a whole set of policies where they are moving demand away from housing.

‘‘So they’re in a housing slump, and are in an economic slump, but it’s one they’re choosing.’’

Jones is referring to what Chinese Communist Party general secretary Xi Jinping says is a ‘‘window of opportunity’’ for China to iron out major vulnerabilities in its financial system by accepting a slower growing Chinese economy.

These vulnerabilities include their huge reliance on property and construction, which makes up almost a third of the economy by some measures. Those imbalances have created Evergrande, the country’s largest developer, which has racked up debts of over

US$300 b, bills it might not be able to pay.

There are hints of further roadblocks ahead, not only from China’s crackdown on some of its most profitable technology businesses, but from the United States. A recent report to Congress suggests the US might look at putting in major restrictions to the flow of capital between China and the United States.

China is New Zealand’s largest trading partner, but we will now be faced with a China no longer committed to the breakneck growth of the past.

All of this at a time when Covid19 has also killed off one of our big foreign exchange earners: Tourism. The Government does not seem keen to welcome back tourism in the form we once had it, and even if it did, it is not clear people are keen to travel in the same way they once did.

Jones says it is looking likely New Zealanders will start travelling abroad before inbound tourism returns.

The Government has also signalled its desire to shift away from letting in larger numbers of tourists, and it remains to be seen whether its ‘‘pivot’’ to higher-value tourism really compensates for letting in a lower number of tourists through the gates.

‘‘To get a stronger New Zealand dollar, you would need a strong China. And you need the return of tourism and international travel,’’ Jones says.

New Zealand may well experience in 2022 what other countries have already been through: A major public health crisis in winter, and a community reluctant to return to the office or visit cafes and bars.

Business

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2021-11-27T08:00:00.0000000Z

2021-11-27T08:00:00.0000000Z

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