Opinion: Mortgage maturities push up swap rates

By Roger J Kerr The steeply upward sloping interest rate yield curve has taken a slightly different shape over this past week. A new bulge upwards in the two to four year swap rates is reflecting market positioning of the banks as they move early to pay fixed rate in the wholesale swaps market to hedge the bulge in residential fixed-rate mortgages coming up for renewal and being rolled into new two and three year maturities. It certainly tells you something about borrowers and investors expectations of future interest rate levels when the 2-year swap rate at 4.00% is nearly 1.00% above the 1-year swap rate at 3.00%.

What the market is saying is that the RBNZ may hold short-term rates down at the artificial low levels below 3.00% for another 9 to 12 months, but after that short-term interest rates will shoot upwards as monetary policy settings are adjusted away from the current "super-loose". The RBNZ are not at all worried about inflation as the economy remains in recession, however in 12 months time they will not be so complacent towards the inflation risk. It is a fair expectation that in 12 months time monetary policy will be set at more of a "neutral" position i.e. 90-day rates somewhere between 5.00% and 6.00%. From a borrower's perspective it is no longer a straight-forward and compelling argument to fix for whatever term and disregard the gap to 90-day rates. There are some very large premiums to pay for the comfort of being fixed over the exposure to floating rate risk. Three months ago when the fixed swap rates were considerably lower from where they are now, it was an easy decision to fix and the vast majority of our corporate clients did so at very attractive interest rates. The risk that was hedged three months ago was that term swap interest rates would increase. They have now done so, and the risk today of term swap rates rising another 1.00% is much less than it was. There is inevitability about 90-day rates rising sharply in 12 months time, but how far above 5.00% they will go is a real question. Much depends on the track of our economy out of recession. Difficulties and challenges for our two largest industries, diary and tourism, suggest that the export-led recovery to positive GDP growth 2010 will be very hard earned. The premature rise of the NZD against the USD also weighs down the general export performance over the next 12 months. I do not think +2.00% annual GDP growth in 2010 will be sufficient to generate real inflation risks and justify a monetary policy setting above 6.00% short-term interest rates. The net result of this analysis and where the interest rate market has got itself to, is that both 90-day rates and term swap rates travel sideways for several months from here. I do not see who the investors will be to drive swap rates lower. However, the fixed rate paying demand on the other side of the market from borrowers will reduce in intensity once we get past the current bank mortgage book hedging. GDP figures this Friday for the March quarter have the potential to surprise i.e. not as bad as the -1.0% and -1.1% the RBNZ and Treasury are forecasting. It will be a real kick in the guts for those public sector forecasters and associated doomsayers if the contraction over the quarter is nearer to 0% than -1.0%. Either way, no impact is expected on the interest rate market. "”"”"”"”"”- * 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