JPMorgan explains the market impact of the shock New Zealand election outcome

New Zealand’s new PM, Jacinda Ardern. Picture: Getty Images

New Zealand’s Labour party has carried off an extraordinary coup, securing power through a deal with the conservative NZ First party.

Here’s an excerpt from a rapid-fire reaction note from JPMorgan analyst Ben Jarman on what it means for markets and economic policy.

On the fiscal side, nothing has yet been announced, but on Labour’s announced platform, National’s legislated tax cuts for next year would be unwound, replaced with longer-dated easing through spending programs in education, and perhaps new infrastructure projects, which would likely involve some planning lags. Labour’s long term spending and debt cap commitments are higher than National’s, while NZ First also has an ambitious infrastructure agenda in Auckland and in regional development. The perception is then for easier fiscal policy under Labour, but it may take longer to eventuate.

On immigration, where application of NZ First’s policy (cuts from 70,000 net annual intake to 10,000) would have the greatest growth and housing implications, Ardern indicated that Labour’s existing policy hadn’t budged. This seemingly removes an important downside risk to the growth outlook, and it is similarly hard to see how the Green Party could have voted for deep cuts anyway given their manifesto.

On RBNZ reform, both Labour and NZ First have pushed for a dual mandate, as well as a move away from the sole-decision-maker model to a committee structure. Peters had also campaigned on a shift to the Singapore model (FX basket targeting), though not surprisingly, was not able to secure this in negotiations, again removing a key economic risk.

The divine coincidence of inflation and unemployment targeting dictate that a dual mandate shouldn’t actually shift the policy reaction function, and RBNZ officials will likely be at pains to point this out, reminding the market that their inflation forecasts depend on their output gap forecasts and so on. It is a similar story with the move to a committee structure: committees are already convened as part of the decision process, even if the final say is technically with the governor. The only material difference under a committee would be the possible involvement of outsiders (non-RBNZ officials, like the RBA model). This is an important uncertainty to think about, and an option we think the RBNZ would fight, but which we don’t have much visibility on at the moment.

On a practical basis, what changes to the Reserve Bank Act will mean is that the crafting of the new PTA and selection of the new governor could take longer, and last deeper into caretaker governor Spencer’s term. And, even if the RBNZ do not become any more dovish per se due to mandate changes, fiscal stimulus is important in propping up growth next year in the RBNZ’s forecasts, so if it arrives later under Labour’s policies, that could be decisive for monetary policy settings.

Market implications:

Somewhat unusually relative to recent election-related volatility events, the surprise came not from the people (the vote shares matched the final polling); it was the body politic that has surprised. Nevertheless, for markets, this outcome is not the expected one, following National’s first past the post result in the election. There had only been some nods and winks to a possible Labour win in the last week or so.

This suggests not much risk premium had been built back in for a change of government after the election outcome a month ago. NZD/USD is down 1.6% since early Asian trading today. We had nominated an NZ First/Labour/Green result as worth 2% off NZD in the absence of material policy changes to Labour’s baseline, which designates 0.7000 as the approximate first stop. For the change of government alone to make this result hold and extend, there would need to see more growth- or capital-flow-negative policies come out than we have heard thus far.

The NZD curve should also steepen, led initially by the front end, on the reforms to the RBNZ. We have not wanted to overplay the significance of the election for the economy or monetary policy, as in our view the case for removal of RBNZ hikes in market pricing would stand on its own grounds, given the dynamics in growth and housing. But this may be enhanced in the near-term given perceptions around the new policy set.

Over the longer term, the central bank doesn’t choose rates so much as the performance of the economy and markets do, and in this way the dual mandate could matter most through an effect on inflation risk premia. Central bank decision-making and communications would also become somewhat foggier (many voices etc) under a committee structure, which adds to term premia, as does the prospect of longer-run fiscal easing.

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