The Reserve Bank of New Zealand’s surprisingly large rate hike last week, intended to keep wholesale interest rates from falling, has seemingly failed to do the job.
While 90-day bank bills rose 25-basis points in sync with the Official Cash Rate, longer term rates have hardly budged. The two-year swap rate was 5.01% at 9:30 am on Tuesday morning, down two basis points from the prior Monday.
The five-year swap rate was five basis points lower than it was at the start of last week, meaning any increase to wholesale interest rates triggered on Wednesday didn’t even survive the weekend.
Mortgaged households, who are already feeling squeezed by existing interest rates, should take comfort that retail lending rates are unlikely to increase from here.
Jason Wong, an interest rate strategist at BNZ, said the central bank had been concerned lower swap rates would flow through to retail rates and was trying to prevent that from happening.
“But the move has back-fired, with swap rates lower last week, and the two-year rate ending the week only three basis points higher than the level prevailing just before the RBNZ’s statement”.
Traders were aware the weighted average mortgage rate would likely rise over 200 basis points even with no change in swap rates, and didn’t see any need for more increases.
The RBNZ’s big move only flattened the interest rate curve - meaning short term rates increased while longer term ones fell - because traders thought higher rates now will mean lower rates in the future.
Ross Weston, a senior treasury portfolio manager at Kiwibank, said retail mortgage rates had barely moved despite a 25 basis point fall in wholesale rates since February.
The central bank appeared to be targeting wholesale rates which could, in theory, put a floor under the whole market.
“If wholesale rates fall too far, then the RBNZ comes out hawkish? Is that the new modus operandi,” he asked in a note.
While traders have priced in another rate hike in May, they have also brought forward their expectations for rate cuts.
“This is the problem with lifting the Official Cash Rate in large chunks. What goes up needs to come down (rapidly) and the inverted curve is testament to this”.
Tug-of-war
In essence, traders think that any additional hikes will come with equal-sized cuts and longer-dated interest rates could plausibly fall in response to increases in the OCR.
The reaction to Wednesday's hike demonstrates how the RBNZ’s policy holds the most sway over short-term interest rates, while market forces dictate the rest.
With traders and the RBNZ stuck in a tug of war, most mortgage rates may have found their peak.
Craig Ebert, a senior economist at BNZ, said it may look like the central bank’s big hike had backfired but that was only speculation.
“The truth is, we’ll likely never know if the Bank has grossly misjudged things, as we don’t know the counterfactual. Might swap rates be even lower now, had the RBNZ not done what it did last week?”
In any case, foreign investors have been willing to buy into NZ interest rates over the past week, betting that they will fall, and the RBNZ’s hawkish stance may have prevented a more meaningful decline.
Westpac economist Imre Spizer said there was potential for two-year swap rates to climb back to their recent peak at 5.5% which most mortgage rates have already priced in.
Mortgage holders have been opting for shorter-term rates in recent months, likely on the expectation that this is as high as rates will go.
Floating rates have been following the OCR higher and will continue to do so, but fixed term rates have already declined this year - albeit only marginally.
15 Comments
Unusually, I agree with Craig the banker. Given where the pivotal US treasury market has moved in recent days, it is quite likely that a freeze or 25 point hike in the OCR would have seen 1-year rates drop by more (and we may have seen bigger drops in currency values too).
We are now so exposed to international finance and trade that it is questionable whether we even have the monetary sovereignty that RBNZ think we have. For example:
- We are a price taker for goods and services - imported prices + local margins determine most of our domestic pricing
- The price we can charge for our exports determines the rest of our local prices (particularly meat and dairy)
- Our bond market swirls around in the backdraft of US Treasuries
- Our exploding trade deficit means we now have $60bn of bonds owned overseas (with interest payments adding to our current account deficit)
The sooner we regain some of our sovereignty by pursuing something smelling vaguely like an economic strategy the better.
The sooner we regain some of our sovereignty by pursuing something smelling vaguely like an economic strategy the better.
Well said indeed! We seem to have no strategy whatsoever unless you count doing the same old things while expecting a different result. Moribund would be a good way to describe it. Meanwhile, some political parties are presenting reasoned alternatives, TOP for example, but precious few else.
Without being glib, I think the OCR controls the one-year and has varying influence over the rest depending on what else is going on. RBNZ would have to intervene (like BoJ) to control the interest rates across 1 - 10 year timeframe, and I am not sure they have the guts or the trade surplus to make a success of that kind of yield curve control.
Results for Treasury Bill Tender 1727
And the most recent US 1 month Treasury Bill price action versus Fed funds.
We hiked by 50pb and got a 17bp 1y increase (and the rest went down). Sure, maybe 25bp was already priced in (but some though we might not raise). If we hike another 50bp will it be passed on or will the OCR end up above the 1y?
I don't think any of these central bank policies work if the markets don't want it. Are you suggesting the RBNZ sells it's LSAP bonds and realises the losses? But i guess when the govt covers the losses I guess that would raise rates, one way or another.
The last few years (decades in Japan's case) show that central banks can control rates across the yield curve if they are prepared to back up their signals (e.g. we will hold 10-year rates at X%) with bond purchases (mostly) and sales. The ECB, for example, has controlled rates across the yield curve for all Euro countries for the last few years, even setting the spread between countries (eg keep Spanish rates higher than Germany!)
The question that needs to be answered here is how much higher would rates have been in the counterfactual. I don't the effect can be larger than 100bp (LSAP here might have got us 50bp tops). Would the market have wanted higher rates in Japan without inflation?
Was the ECB setting the spread "arbitrary" (some technocratic theatrical formula) or did it chose values the market would tolerate?
To me working would be achieving policy objectives not just being able to manage rates.
What worries me is the number of people (probably not readers of this site, but fairly common outside of it) who think the OCR is this big shiny knob the Government uses to determine how much people's mortgages should cost. They have no concept of Reserve Bank independence, or the fact that mortgage rates are influenced by many factors besides just the OCR. They are convinced that mortgage rates will never get too high, since that would screw over too many people, and the Government would never let that happen; either because they truly care about us (lol), or if they did let it happen they'd simply be "voted out" (also lol). They believe the Government is hamstrung; they have no option but to underwrite the entire housing market, and therefore you just can't lose.
This kind of thinking is an absolute recipe for disaster, and a good example of why at least some level of financial knowledge should be getting taught in schools.
Sure, you could teach people it's not that simple as a "knob" (then moral suasion might stop working) but I am not convinced there is any consensus on how this all works in the real world. There's no obvious "curriculum" on anything and the govt teaching everyone that they can or can't control things is very political and not something they would be too keen on.
I think there is a good chance, we are all about to get a good lesson on not trusting the govt and central banks about money and the economy soon anyway.
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