Macroeconomic Outlook for 2022: A Shaky Start to the Year

Well, it's been a bit of an unsettling start to 2022, and doubly so for those keeping an eye on their investments. 

Omicron is taking its predictable but unnerving course across New Zealand. Overheated economies around the world are seeing tight labour markets and spiking inflation. Interest rates are expected to rise in response. And to top it all off, Russia has declared war on Ukraine, which has seen markets experience further volatility. 

Here are the key themes from our latest episode of the ASB Investment Podcast, with host & Senior Economist Chris Tennent-Brown and Senior Economist, Mike Jones. 

COVID's effects on investments and society have dominated life for the past two years. But it seems to have created disruption rather than actual change.

As Chris says, "Two years ago we thought COVID was a real game-changer for the economic outlook. But it's really been a pause. We're now back to facing some of the problems that we faced in late-2019, the tight labour market being one of them, which has actually just got worse."

Higher interest rates will become an increasingly positive story for bond investors. But in the meantime, existing bonds with lower rates will lose some value in the short term.  

Chris points out that changing rates in 2021 made a big impact in bondholders' investment portfolios. "So, ultimately, I think it's good news that we're moving back to a more normal interest rate environment. That's good for the running yield of a bond portfolio. But the transition is a big headwind for returns, and we can see that over the past year."

Economists across New Zealand were surprised by the New Zealand dollar's drop in value over the last month or so. 

Mike summarises that the normal fundamentals that drive the Kiwi dollar are the prices our key commodities fetch offshore, and our interest rates relative to the rest of the world," explains Mike. "Both of those were big screaming green arrows last year - but the currency fell. I guess it highlights the old issues around trying to pick currency movements."

It's another inflationary pressure for consumers - but it's great news for exporters.

A lower exchange rate means they bring home more New Zealand dollars from the same overseas sales, which is good news for the economy.

Plus, our key commodities, like dairy, are trading at record highs at the moment, so the rural economy is enjoying a rare double-dip of profitability.

Mike says this is the most rapid increase in mortgage rates in about 15 years - this is important because it's not always the level of mortgage rates that really matter for house prices. It's the speed at which they change because that’s what feeds through to mortgage borrowers' back pocket.

"About 60% of all mortgage holders on fixed rate mortgages are going to roll those rates over the next 12 months. So those big increases will be felt in short order, and probably slow down spending."¹

As well as interest rates, accelerated building programs are increasing the supply of new homes, tighter lending laws are making it harder to borrow, and changes for property investors make owning rentals less attractive. All these pressures are adding up. 

"It's hard to know which factors are doing all the work, but markets seem to be losing steam a bit earlier than we might've thought. We forecast a fall in house prices in the second half of this year of about 3%, but now we've doubled that. The excess demand that pushed prices up so aggressively has started to drop. So, with the supply side rising, we're looking at a much more balanced market, which is ultimately a good thing."

Share markets have responded to inflation, interest rate increases and international tensions with a lot of volatility. Chris feels that the underlying nervousness leads to exaggerated swings in share prices: "If any companies disappoint, the market's very sensitive to that and their share prices are hit significantly lower. It just seems that the market now is very sensitive to this interest rate and inflation outlook and what it means for any growth."

Despite these recent falls, share markets are still at relatively high levels, and at roughly the levels we were seeing in October last year. 

Finally, there's the impact of migration - or rather the lack of it for the past two years. Traditionally immigration is seen as a driver of house prices and more fluid labour markets. 

"Immigration is normally such a big and important factor when you're thinking about housing demand in New Zealand and hence the prices of those houses. When immigration froze overnight, most people thought wow, that's a big hit to demand, house prices might fall quite a lot. But Kiwis were quite capable of generating a housing boom all by themselves."

But of course, open borders mean two-way traffic. As Mike says, "Reopening the borders might not lead to a loosening of our labour market. It may be that more Kiwis head offshore to pursue opportunities as well. So, I guess that's one of the big uncertainties we're grappling with for later this year."

This has just been a taste of the full podcast. You can listen to Mike and Chris' full conversation and get many other investment insights by listening to the podcast on Spotify and Apple Podcasts. 
 

¹ RBNZ New residential mortgage and standard interest rates: https://www.rbnz.govt.nz/statistics/b20-new-customer-average-rate