Reserve Bank governor Adrian Orr has pushed back the bank's forecast for the first interest rate cut to September next year. Photo / NZME
“Watch, worry and wait”, “Higher for longer” . . . this interest rate cycle is taking so long to turn that it has earned its own catch-phrases.
It is a frustrating wait for business owners and mortgage holders struggling with high borrowing costs.
But for those following capital markets closely, the wait probably seems even longer — exaggerated by the “watched pot” effect of market expectations getting ahead of central banks, only to be unwound by persistently stubborn inflation.
We all know the theory. High interest rates make safe “cash” investments like term deposits and bonds look good. Equity markets struggle as returns look less lucrative relative to the risk.
If you follow United States market news then you’ll be used to the soap opera of economic data and US Federal Reserve commentary that sends markets up and down on a near-daily basis.
So far this year the direction hasn’t been great for equity markets.
To get a sense of how far interest rate expectations have been pulled back you just need to look back to the start of the year when six 0.25 per cent rate cuts (by the US Federal Reserve) were priced in.
Current pricing suggests we might be lucky to get one now.
That might have changed by the time you read this of course. It only takes one better-than-expected jobs number or worse-than-expected manufacturing figure to change the equations - all of which remain hypothetical.
Broadly the US economy has continued to outperform and, while inflation has continued to fall (it currently sits at 3.36 per cent for the year to April 30), the last per cent or so has proved stubborn. The US Federal Reserve has been reluctant to move early for fear of sparking a rebound.
Perversely (and thankfully for investors) we’ve seen US markets continue to hit new highs.
But Wall Street’s overall performance has been flattered this year by tech stocks riding high on the AI boom.
The so-called “magnificent seven” - Apple, Amazon, Alphabet, Meta, Nvidia, Microsoft and Tesla - have all outperformed the wider market.
The star of the show has been Nasdaq-listed computer chip maker Nvidia which has seen its value rise 200 per cent in the past year (more than 3000 per cent in the past five).
Its market cap topped US$3 trillion this month, taking it past Apple to become the world’s second most valuable company.
For those of us who lived through the dot.com bubble and the tech wreck of 2000 the excitement about AI can be worrying.
Yes, AI is coming to change the world. But whether it can be adopted by businesses - and start delivering financial returns on a scale that the current valuations imply it will - is another matter.
At the turn of the millennium, we learned the hard way that timing is everything in tech investment. Though we could all see the internet’s potential, it failed to deliver the promised profits in that first flush of market excitement.
Within a decade the rise of ultrafast broadband, the iPhone and social media giants like Facebook had utterly changed the world.
But that didn’t help investors in 2000 when the Nasdaq tumbled.
Perhaps AI will be different but there is a difference between demonstrating the technology with jaw-dropping chatbots and video generators and integrating it into business.
One thing is clear, the world can’t afford a repeat of the tech wreck right now.
While higher interest rates remain, the less glamorous bricks-and-mortar end of the investment world will continue to face headwinds on growth.
That makes the giddy heights of the AI boom all the more precarious. The sector is effectively propping up the returns of the world’s retirement funds - including our KiwiSaver accounts.
How long it can keep doing that is anyone’s guess.
How long until interest rates fall and the weight of capital pushes it into catch-up mode is a little clearer - but not much.
In New Zealand, it’s no secret that the performance of the NZX50 has been lacklustre.
Lacking a tech sector star to lift its average return, it is up about 2 per cent year-to-date.
We’ve seen inflation fall away in the past year (currently 4 per cent) but sadly the economy has not followed the US lead.
We entered a recession in the first quarter of 2023 and while there are signs we may have bounced out in the first quarter, expectations are that growth will remain low for at least the next year.
That’s added another headwind for local companies. And if anything it makes the wait for lower rates even more acute for local investors.
So how long will we wait?
The bets on the first interest rate cuts are now widely spread.
As recently as May there were market expectations that rate cuts could come as soon as August. Economists saw that as over-exuberance but were still prepared to put good odds on a November cut.
That optimism has been tempered in the past few weeks by a hawkish Monetary Policy Statement from the Reserve Bank which pushed back its forecast for the first cut until September 2025.
That outlook may be all part of the great game of monetary policy “jaw-boning” or as ANZ’s chief economist Sharon Zollner puts it - “bluffing for strategic reasons”.
The Reserve Bank wouldn’t accept that, preferring instead to explain the hawkish outlook by leaning on the hypothetical nature of forward rate tracks.
But economists, even the hawkish ones, don’t believe we’ll be waiting that long.
Kiwibank, which has been arguing for a November cut, is now leaning towards February. Both BNZ and Infometrics have shifted forecasts from November to February. The ASB and Westpac teams still have February tentatively pencilled in but with risks tilting toward a later cut. ANZ has also just shifted its view to February.
Infometrics chief forecaster Gareth Kiernan has warned that the Reserve Bank has taken a backward-looking approach to inflation targeting across the past three years and if that continues we could see restrictive monetary policy limiting business growth as far out as 2027.
“We hope that the additional six-month wait in the bank’s current projections for an OCR cut, until the second half of 2025, is more about preventing financial markets getting overexcited about rate cuts in the near term, rather than a genuine indication of what will eventuate,” he wrote last week.
“But given the bank’s recent rhetoric, it would be a brave person to completely rule out the OCR staying where it is, at 5.5 per cent (or above), for another year.”
That sentiment that seems a wise one for market watchers to take on board.
Liam Dann is business editor-at-large for the New Zealand Herald. He is a senior writer and columnist, and also presents and produces videos and podcasts. He joined the Herald in 2003.
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