Battle of our Central Banks: RBNZ v RBA who will blink first?

Reserve Bank Governor Adrian Orr. Photo / File

COMMENT: Traders and investors have been paying extra attention to central banks in recent weeks following policy u-turns from two central bank heavyweights, the US and China, which have resulted in a strong recovery in stocks over the first quarter of this year.

Regionally, we have seen a similar phenomenon as a result of (less dramatic) shifts in policy from both the RBNZ and RBA, with both organisations having indicated that their next move in interest might be up to current levels.

With guidance now for a more likely cut in interest rates, however, the markets are already pricing in the probability of a cut of 0.25 per cent in Australia within the next three months.

Exposure to global markets and China

Australia has a disproportionate level of exposure to China, both direct and indirect - with 42 per cent of exports going to the region, and a further 21 per cent to countries such as Japan and South Korea which both carry a large exposure to China.

New Zealand has done a better job of diversifying, with China accounting for roughly 27 per cent of exports. Australia, however, still makes up a significant portion of our total exports - and as they slow we are likely to experience some of those knock-on effects.

Of concern to Australia, is that China's current reflationary efforts appear to be different from those of 2009 and 2016. Stimulus are more domestically focused, and they have shored up capital controls as they manage their economic transition from purely export driven to a more value add export model and domestic consumption - much like that of the United States.

The fate of the Australian economy has become highly correlated to Chinese Fixed Asset Investment and industrial production – meaning the Australian Business model is under pressure, and may be broken. There has been some optimism recently with a surge in iron ore and copper, but these are arguably more supply side disruptions than a meaningful revival in demand from China and elsewhere.

Meanwhile, dairy markets have picked up in recent months, further supporting New Zealand's outlook over that of Australia.

Yield curves

There has been significant media attention dedicated to the potential recessionary warnings heralded by the recent inversion in the yield curve of US sovereign bonds.

Our bond markets have been sending similar signals with yield curves flattening in both Australia and New Zealand, and a number of inversions in Australia over recent months - signalling potential headwinds for both economies.

Looking ahead

Australia's economy is facing considerable pressures – globally, as a result of slowing economic growth in China, Europe and Japan, and domestically, with the turning of their property market resulting in more material price corrections in key cities like Sydney and Melbourne.

We're seeing the housing slump filter through into consumer confidence, which typically affects business confidence. This could further slow capital expenditure, which in turn could see their job market cool.

The global slowdown will have an impact on New Zealand too, but we are better diversified than Australia, and our debt levels less extreme. When our correction comes, we may not dip as deep as our neighbours.

Given the conditions and data, there are causes for concern on both sides of the Tasman, but it is clear that Australia is positioned poorly and we are likely to see their central bank react first.

While we could expect our central bank to follow should China not have a material recovery over 2019, we could see the RBA pressured to do more, outpacing New Zealand in an effort to ensure a softer landing.

Currency traders in New Zealand favour trading the AUD/NZD pair – and many are surprised by the resilience of the NZD against the AUD. They may also look to trade the AUD/USD alongside the cross, as the potential AUD weakness may be more pronounced against the USD and JPY than against the NZD. Lower interest rates may also see more money flow into dividend paying stocks both locally and in Australia.

- Sheldon Slabbert is a Sales Trader at CMC Markets.