Last week, the Reserve Bank of New Zealand (RBNZ) lowered interest rates to 2.25 percent in a move widely regarded as surprising. Why that view was surprising is actually what is surprising because prior to the cut last week, RBNZ had already pared borrowing cuts four times in the past year and long gone have been the days when it looked like RBNZ would join with the Federal Reserve as the developed market central banks bold enough to raise rates.
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One more rate cut and New Zealand will tie Australia with benchmark interest rates of 2 percent. That prospect is certainly on the table because RBNZ did not say anything to make anyone think anything but more cuts are on the way.
RBNZ policy is not doing much to stir the iShares MSCI New Zealand Capped ETF (ENZL), which has traded modestly lower over the past week. To be fair to the lone New Zealand exchange traded fund listed in the U.S., ENZL is up 9.2 percent over the past month.
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Buoyed by rising commodities prices, ENZL is up 2 percent and although interest rates in New Zealand are falling, the ETF sports a tantalizing trailing 12-month dividend yield of 4.4 percent. Still, there are some issues to be mindful of with ENZL. Fitch Ratings said New Zealand's low interest rate environment with hurt bank profitability there.
Additionally, a weaker New Zealand dollar, while mostly seen as a positive for New Zealand's export-driven economy, is not necessarily good news for ENZL because the ETF is not a currency hedged fund. The bottom line with ENZL is that the ETF debuted in September 2010 and over those roughly five and half years, the fund performed better when the country's rates were high and its kiwi (NZD) strong.
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The rate cut should put downward pressure on the NZD/USD exchange rate, helping to spur growth in service exports and supporting employment. It will also particularly benefit households - in light of high household debt, and stagnating house-price growth in Auckland. Residential mortgages dominate New Zealand banks' household exposure, and the improved serviceability that will come with low rates should help to maintain asset quality for this sector in the short term, said Fitch.
Applying U.S. interest rate logic to ENZL, lower rates should be of some benefit because the ETF allocates a combined 31.5 percent of its weight to utilities and telecom stocks.
New Zealand's banks will continue to benefit from strong franchises, parent support and generally stable funding profiles despite the ongoing challenges from the macroeconomic environment. Banks are well capitalised - sufficient to withstand significant losses that would be caused by a major shock in either the housing or dairy sectors - and should be strengthened by continued issuance of hybrid issuance in FY16. Each of the four major New Zealand banks are rated 'AA-/Stable', adds Fitch.
Financial services stocks account for about 9.5 percent of ENZL, the ETF's seventh-largest sector weight.
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