Hamish Rutherford: Even in a recession, what is the right price of assets, when interest rates fall close to zero?

Reserve Bank governor Adrian Orr. The central bank has taken extraordinary steps to lower interest rates, a move likely to support asset prices. Photo / Mark Mitchell

COMMENT:

Covid-19 may represent the greatest threat to the economy since the Great Depression, but the effects so far look grossly uneven.

Since the start of lockdown tens of thousands of Kiwis have signed up for job seeker payments.

While it could take months to digest where the pain has fallen, the sectors most in jeopardy - retail, tourism and hospitality - employ predominantly young people, especially women, on modest wages.

A strong labour market tends to lure those who would otherwise be in education or domestic duties into the workforce, encouraged by opportunity. Economists credited this for the participation rate among women hitting record levels in the past few years.

Covid-19 may have caused the opposite to happen in some cases, as people leave education out of need.

This week Peter Jones, the principal of Manurewa High School, New Zealand's largest decile one high school, claimed 200 students - 10 per cent of the school's roll - had not come back after lockdown, as they opted to enter the workforce to help support their families.

Back in March, Covid-19 threatened to cause financial meltdown, but steps to settle markets may have ensured that those who own assets are feeling little of the pain.

One property developer whispered this week that Covid-19 could be "the poor man's recession". For those with wealth, conditions are much less bleak.

On Thursday, Reserve Bank assistant governor Christian Hawkesby gave a speech looking back at the past six months.

"It is hard to overstate the strain on global markets through this period," Hawkesby said, pointing out that March saw the S&P-500, the US benchmark share index, recorded two of the six largest falls of the past century, both worse than any day in the global financial crisis of a decade ago.

His speech explained the steps the Reserve Bank had taken to fend off dysfunction in the credit markets, including a pledge to buy up to $100 billion worth of bonds in a bid to lower interest rates.

What his speech did not highlight was how the S&P-500 has performed since. Earlier this week, on a day that the United States recorded more than 40,000 new cases of the virus and more than 500 deaths, the S&P-500 hit an all time high.

Our own NZX-50, which also dropped sharply in March, has recovered almost all of its gains, sitting around 4 per cent from its record high of February.

This is a far more dramatic bounce back than was seen a decade ago; following the GFC, the indexes took around five years to recover losses. This time it has taken less than six months.

With consumers expected to spend less over the next two years, migration slowing dramatically and international tourists gone, the recovery in share prices hardly looks to be driven by optimism about earnings growth.

Instead, low interest rates are once again driving higher asset prices, despite the clear underlying damage to the economy.

The sectors most in jeopardy - retail, tourism and hospitality - employ predominantly young people, especially women, on modest wages. Photo / 123RF

The bounce in asset prices is not limited to the share market. When the country went into lockdown economists predicted substantial falls in house prices this year.

Usually, nothing is more unsettling for the housing market than the prospect of a sustained rise in unemployment.

So far, the drops have not materialised. This month the Real Estate Institute of New Zealand reported that July represented the strongest month of sales in Auckland in five years, and in the rest of the country in 15.

Even with a marginal dip in prices in New Zealand's largest city, prices nationwide climbed 3.5 per cent in a month, and almost 15 per cent over the past year.

Westpac economist Michael Gordon said while this in part reflected pent-up demand from buyers following lockdown, it was "just as true that there is pent-up interest to sell".

Westpac cut back how much it expects prices to drop this year from 7 per cent to just 2.5 per cent.

This was before the Reserve Bank gave the market the strongest indication yet that it is prepared to slash its benchmark official cash rate (OCR) below zero, an extraordinary measure likely to come with a new programme to lend directly to banks at ultra-low interest rates.

All of the major banks now forecast that by the middle of next year the cash rate will be below zero, and that what consumers pay for credit will fall materially.

Bank economists are paid to predict what will happen, not what should happen, and there were a string of warnings about the risks of negative interest rates.

"If you allow these programmes to become too big or run too long, you end up with a banking system that becomes dependent on it," ANZ chief economist Sharon Zollner said. "They're easier to get into than out of."

BNZ's head of research Stephen Toplis said while borrowing rates seemed likely to fall considerably "is it stimulating the economy, or is it providing low costs for speculators".

Cameron Bagrie said the Reserve Bank was "desperate to underpin asset prices and the side effect is worsening income inequality".