Opinion: A wild ride in the interest rate swaps market

By Roger J Kerr The panic and rush to fix interest rates by both household and corporate borrowers last week, that caused a mad scramble in an illiquid inter-bank swaps market, tells us a lot about Kiwi financial psychology. The vast majority of investors still see property as their preferred and dominant asset class, and when they can leverage debt at a 6% cost to earn a 8% or 9% return, they are right into it. The one-sided demand to pay fixed in the swaps market was compounded by some corporates also panicking to fix as they suddenly realised that rates saw their bottom in February. This violent reaction upwards was always going to happen at some stage, and when the market turned upwards there were no fixed rate investors/receivers, only payers. Such is the risk and price we pay in a small market. For these reasons the more aware and savvy borrowers had been averaging-in to a higher level of fixed rate debt since December. No-one ever knows where the bottom will be, we just know that when it is realised there are a lot of panic-merchants about. The absence of global investment bank players such as Goldmans, Morgan Stanley and JP Morgan in the NZ swaps market these days means that the liquidity levels are not what they use to be. Likewise the local fixed interest fund managers are more likely to have been closing-down receiver swaps entered at higher levels last year to lengthen their portfolio durations. They will now be positing their durations well short of benchmark by paying in the swaps market. The main trading banks were also panicking last weeks with knee-jerk increases in 5-year fixed rate mortgage interest rates from the low 6.00% area to above 7.25%. With the 5-year swaps rates reversing back to 5.00%, the resultant bank lending margins are now very healthy indeed. The appreciation of the NZD has moved overall monetary conditions/settings to a position looser than in January and February. The RBNZ will not be over-reacting to this change and a move back down in the Kiwi will remove any concerns. Short-term interest rates will remain near their lows for many months yet, and will only start moving up when the economy improves much later in 2009. ---------------- * 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