Opinion: The exchange rate has stuffed us up

By Roger J Kerr The argument that the interest rate market is now starting to price too far ahead of itself is gaining some credence as the two to four year bulge in the yield curve expands even further. There is no question that short term interest rates will increase sharply next year, but how far they will have to increase against a back-drop of a struggling export recovery is debatable. Inflation is not going to be a problem and the RBNZ will keep short-term rates lower for longer if the GDP growth is stymied from the start with volatile and unpredictable currency value. It is becoming pretty hard to see the value for a corporate borrower fixing in the swaps market at 5.00% for three years if 90-day rates stay below 3.50% for another 12 to 18 months. Options appear to be a better hedging method for this maturity now. It seems that the interest rate markets are now focussing on the residential property/consumer spending sectors as the saviours of the economy in terms of pulling us out of recession. The rising Kiwi has just about sunk the export-led recovery expectation. The bank-dominated interest rate market of course has a pretty short memory, as it was the same excessive consumer borrowing/spending that sent the economy into recession in the first place in late 2007 (or the RBNZ's monetary policy response to the debt/spending growth). In my view, the interest rate markets have seemingly forgotten about the very large impact the exchange rate has on our economy. We are now not going to see the stimulation to the export sector (and thus the whole economy) in terms of expansion and investment that would have occurred had the Kiwi dollar staying in the 0.5000's for most of 2009. The weak USD and strong AUD currency trends of recent months have stuffed us up to a significant degree. The interest rate markets appear to be over-looking this economic/business reality. Having said that, the NZ Government's heavy borrowing requirement over coming years does justify the higher five years plus interest rates, just the same as the US. Perhaps the interest rate markets are correctly reflecting the material lift in consumer and business confidence over recent months. These may also not be too sustainable at the higher levels, particularly if the All Blacks lose another rugby test or Wall Street heads the other way! All in all, I may well be reading far too much into the now very steep upwardly sloping yield curve. The NZ market may be simply tracking the Aussie interest rate market which is reflecting a more upbeat RBA, higher hard commodity prices and no economic recession. However, the New Zealand economic situation is not the same as Australia and at some point there will be a general realisation of the differences. A good time for investors to be looking at the value in the two to four year part of the curve, but it's arguably too late for borrowers. "”"”"”"”"”- * Roger J Kerr runs Asia Pacific Risk Management. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com