Opinion: Why interest rates will be higher rather than lower in the long term

By Roger J Kerr As expected, the NZ dollar was not too comfortable holding on to its gains to 0.5900 and his since retreated to the 0.5500 to 0.5700 region. It is just far too early for the currency to be pricing in an economic recovery ahead of other countries. Even though the medium term signs still remain that the NZ economy will be back on a positive GDP growth path ahead of Australia and other countries, it is premature for the currency to be advancing at this time in anticipation of that superior economic performance. For this reason the gains by the Kiwi over recent weeks were not sustainable and traders were quick to take profits on long-NZD positions. The timing and strength of the expected export-led recovery is still under some considerable debate. GDP growth forecasts for 2010 range from 0% to +4.00% (RBNZ). The short-term focus is on the RBNZ's OCR review on 30 April, wherein they are expected to cut the OCR by either 0.25% or 0.50% from the current 3.00%. Part of the NZD pull-back from 0.5900 to 0.5500 was in connection to this widely anticipated interest rate adjustment which will close-up the US:NZ 90-day interest rate gap again. However, the medium term view on this highly influential interest rate differential is that the gap will start to widen later in 2009 and into 2010 as NZ interest rates increase ahead of any move back up in official US interest rates. The steepness of the NZ interest rate yield curve from 3.00% for 1 year money to 5.40% for 10 year money provides a very clear message of where both investors and borrowers believe short-term rates will be in the future i.e. considerably higher "“ not lower! It would seem that only another wave down in local retail and housing markets during this winter could force the interest rate market to change and price fundamentally different to the current yield curve. The latest Roy Morgan Consumer Confidence survey has lifted upwards, suggesting that the job insecurity that may be about is not sufficient to drive the domestic economy any lower than it already is. Over coming months improving export performance is more likely to come through in the economic data rather than further contractions in the domestic economy. Therefore, further RBNZ interest rate cuts below 2.75% or 2.5% appear unlikely. The NZD has already adjusted downwards over the last 12 months to the massive change in interest rates from above 8.00% to below 3.00%. These adjustments have now both run their course. The key determinant for the Kiwi looking forward is when and how the economy recovers. Export prices and volumes in the big export industries such as meat, dairy, fishing, forestry and horticulture over coming months will determine that process. Anecdotal evidence suggests that these industries are more profitable today than they were two years ago when the currency and oil price were against them. Focusing on domestic retail and housing spending for signs of economic recovery will the wrong place to look. The recent ultra-gloomy economic outlook for New Zealand from the OECD fell into this trap of looking at the wrong lead-indictor. All previous economic recovery cycles have been led by the export sector. Despite the current highly synchronized global economic recession, it appears that the NZ recovery in late 2009 and into 2010 will be no different. It is unlikely that the end-of-May budget will cause any ructions on the NZ dollar forex market. The budget is expected to meet the requirements of Standard & Poor's, thus no credit rating downgrade to disrupt the Kiwi dollar market. Whilst overseas hedge funds, international investment banks and offshore fund managers are not trading the volumes in the NZ dollar FX market they once did, large one-off capital transactions can still have an impact on the currency market. It would be expected that the Japanese food and beverage giant Kirin would have been buying NZD's and AUD's well ahead of their announced intentions to buy the 60% balance of listed brewer Lion Nathan they do not already own. A few weeks ago it was rumoured in the marketplace that Japanese retail investors were again buying NZ dollars; it now looks more likely that its was indeed Kirin. ---------------- * 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