2008 The Final Quarter

We have just experienced one of the most challenging years for the financial markets.   There has essentially been no safe investment haven except for cash in the bank over the past year.  In some countries even that has not been safe with bank collapses etc.

The real financial markets problem is lack of trust.  Credit dried up between banks, because the banks did not trust each other to not default on their payments.  This in turn put immense pressure on corporates to obtain funding.  There have been some notable corporate collapses overseas, and there has been an impact here with, for example, PGG Wrightson being unable to settle on a large meat company rationalisation scheme as no bank funding was available to them.

Reserve banks and governments around the world have been active in trying to overcome the crisis.  The US Treasury has injected billions of dollars into the financial system.  This has occurred in a number of other countries.  The most commonly used financial tool has been the resetting of official interest rates.  During the past quarter to 31 December 2008 the RBNZ reduced the OCR from 7.5% down to 5%.  At the beginning of 2008, it was 8.50%.  The Australians reduced theirs by 2.75%, the British by 3%, and the Americans by 1.75%.  By the time bank charges are included, it costs depositors to have their money on deposit in America.

We now see bank swap rates ranging from 4.1% for one year, up to 4.95% for ten years.  These are well down and are likely to have a significant impact on fixed interest portfolios moving forward.  This is particularly so for reset securities, as these will invariably be reset at lower rates.  Fixed interest securities with no credit ratings are now at much higher interest rate spreads than what has been common in the past few years on the New Zealand market.  They are now at a spread of around 500 bp above bank swap rates for a similar investment maturity.  Historically they may have been in the 200 – 250 bp spread range. 

We have also seen the advent of Government Guarantees on bank and other approved deposit schemes.  This can be seen as a double edged sword, as it distorts money flows.  Under a free market system, it should be survival of the fittest.  Unfortunately this means that there must be some failures along the way.  Under the Government Guarantee scheme the weakest market participant becomes the same strength as what was the strongest player for the period that the scheme continues.  Effectively taxpayers, including those in the future, are taking on the potential debt obligations of organisations that would in the normal course of events fail or be taken over by their competitors.

Exchange rates have also moved around a lot during the quarter and for that matter the past year.  The USD gained significant strength during the year, and the GBP weakened somewhat.  The NZD moved up and down against the AUD depending largely on the timings of the respective reserve bank interest rate announcements.  The relative strengthening of the USD reflects the so called flight to quality, which invariably occurs in times of economic uncertainty.  It is almost perverse, in that effectively there is just a really large printing press making dollars in the USA.

The past quarter in several countries will have seen negative CPI (Consumer Price Index) figures, largely as a result of massive falls in oil prices.   In the USA, for the three months ending in November, the compound annual rate for the CPI was a negative 10.2%.  It was only a matter of a year ago, that the figure was positive 5% or thereabouts.  We doubt that it is much different here in New Zealand.  How long we, and for that matter many other countries, continue to experience deflation will have a major impact on growth prospects moving forward over the next two years or so.