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03 October 07 |
Hi John,
It’s a waiting game.
Internationally the markets are waiting to see if the U.S. Federal Reserve’s decision to cut interest rates by a whopping 0.5% will settle the turmoil in the financial markets instigated by the sub-prime mortgage debacle.
This was a complete reversal of their previous policy of raising interest rates to combat inflation.
It was done to send a strong signal that the U.S. authorities are prepared to intervene to stabilise the financial markets and prevent the U.S. and world economies slipping into recession.
Accordingly it must be seen as a preventative measure to take the pressure off borrowers and banks who were finding it difficult to borrow money - and not the start of a general decline in interest rates.
It’s interesting to see the different views that have emerged during this credit crunch. The Bank of England took a hard line to start. But then the queues of depositors lining up to take their money out of Northern Rock quickly changed their mind and they made billions of pounds available to banks and building societies there. Interestingly enough though, other than Northern Rock, there were no takers. Sure it was relatively expensive money, but this shows the problem - for now - is localised to certain lenders.
The International Monetary Fund, which supervises the word’s financial systems, released a report that said the collapse of credit markets “has led to disruptions in some money markets and funding difficulties for a number of financial institutions”.
The key lessons they said are:
· Uncertainty and lack of information: Financial markets have seized up partly because they lack information about the underlying risks of complicated financial instruments.
· Unintended consequences of globalisation: While financial innovation, such as “securitisation” of risky mortgage lending, has spread risk more evenly around the financial system, it has also made more institutions [worldwide] vulnerable to those risks.
· Role of credit agencies: Banks have relied on rating agencies to tell them how risky their involvement in these exotic new financial instruments might be, but they have not been up to the job.
They also warned that “the potential consequences of this episode should not be underestimated and the adjustments are likely to be protracted”.
And it does look like it’s going to take some time. To see Reuters article on Stuff.co.nz CTRL + click here http://www.stuff.co.nz/4218230a6026.html And for the effect on investment banks’ profits CTRL + click here http://www.economist.com/daily/news/displaystory.cfm?story_id=9894168&fsrc=nwl
Meanwhile in New Zealand it’s a waiting game too.
Here we’ve felt the consequences of the credit crunch in the non-bank lending markets where funds have dried up. And it’s not just because depositors have fled due to the collapse of several of the finance companies.
Those non-bank lenders with access to funds – through say bank lines – are reluctant to make new loans in case the loans due for repayment cannot be repaid or refinanced elsewhere. This is of particular consequence in the commercial property markets.
Take developers for example. They often take up more expensive short term loans which banks won’t provide – to settle land, get resource consent, market to achieve pre-sales - before being “eligible” for cheaper finance. If this - as it often does - takes longer to achieve than budgeted, they may need to extend the loan.
In this more risk-averse climate lenders are reluctant to do so – especially if it involves capitalising interest and increasing the lender’s exposure.
At Global Pacific we’re even finding banks and non-bank prime lenders not willing to commit to conditional take-outs in the future - as the demand for their funds is so high they don’t need to make forward promises.
So we have a situation where those lenders with funds want to keep cash rich in the event they will need to support existing lenders – or to take advantage of the shortage of funds to make easier more profitable loans.
Is there reason for concern that the credit crunch will get worse in New Zealand?
In the short term probably yes. Some borrowers committed to purchases or projects before the credit crunch will have difficulty obtaining the finance they expected.
But if we look at the world view:
- The Australian and New Zealand economies – the former especially - are being strongly supported by the commodity boom.
- The World Bank rates New Zealand 2nd out of 178 economies in the ease of doing business. To view this report CTRL + click here http://www.doingbusiness.org/economyrankings/
- The global significance of a slowing of the U.S. economy is less now than it has been. The Chinese and Indian economies are booming and becoming more sophisticated. This increases the demand for goods and services provided by the western world. In our Pacific area trade with Asia is becoming more significant.
- Central banks are relaxing the tightening attitude they had previously been taking to ensure financial market stability.
- The world is still flush with money. But the lessons learned mean it will not be as readily available as it has been in the past. Or if it is, the risk will be priced much higher.
There’s a good article by Dr Neville Bennett on the current volatility and uncertainty. To see this CTRL + click here http://www.interest.co.nz/bennett-1Oct2007.asp
The fact is we have not seen the end of inflation – and Neville’s article supports that view. The U.S. Fed’s action to stabilise the financial markets will only make matters worse.
I guess the current messages are.
· The rest of the world now doesn’t necessarily get the ‘flu when the U.S. sneezes.
· Expect volatility in the currency markets. The low U.S. interest rates and the state of the economy there is hurting the U.S. dollar which has depreciated against all currencies. The Aussie and Kiwi are becoming bigger players in the market. To see two articles on the increasing volumes of these currencies being traded CTRL + click here http://www.smh.com.au/news/business/trade-jump-in-australian-dollar/2007/09/27/1190486480576.html for the A$ and CTRL + click here http://www.rbnz.govt.nz/research/bulletin/2007_2011/2007sep70_3smyth.pdf for a profile of the NZ dollar foreign exchange market from the New Zealand Reserve Bank.
· Interest rates are not on a permanent downward path. The European Central Bank has warned that inflation risks are rising and that the ECB must do “what is appropriate for the Eurozone regardless of the U.S. Fed’s decision”. Last week the People’s Bank of China increased interest rates. The Taiwan Central Bank increased its benchmark interest rate on 20th September for the 13th consecutive quarter in a row to combat inflation and stem an increase in investment overseas.
· Finance companies and non-bank lenders relying on the public for funds are still reluctant to make new loans but confidence seems to be returning to this sector. There are lenders still in the market but these have the luxury of choosing the loans they will make. Expect difficulty in raising funds for higher risk ventures in the short term.
It is a waiting game.
Cheers
JP
John Paine B.Sc. Dip BIA
Global Pacific Corporation Limited
112 Gladstone Road, Parnell,
P O Box 3229, Auckland, New Zealand
Phone 64 9 303 3700, Fax 64 9 303 3031
Mobile 64 21 902 004
Email john.paine@globalpacific.co.nz
Web site www.globalpacific.co.nz
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