Opinion: Nearing the bottom, but not there yet

Interest rates continue to plummet around the globe. In this amazing environment of slashing rates to save the global economy from the ravages of economic recession, it is a brave man that attempts to predict just where the bottom of this interest rate down-cycle will be. In the meantime, borrowers just have to go with the flow and leave their fixing at policy minimums. The difficulty and danger from a borrowers perspective in adopting a strategy of waiting to see the bottom form before entering the swaps market to fix, is that everyone else does the same thing and the term swap rates rush upwards to unattractive levels very quickly. We will have to wait for some more positive economic news in 2009 before seeing any reversal upwards in rates, but when it does happen it could rise as fast as recent falls. There are two alternative strategies for a borrower to fix to a higher percentage at rates hopefully near the bottom:- - Start averaging into fixed rate swaps now at markets levels of 5.80% to 6.40% across the curve.  Transact 10% of your total amount you want to increase by now and add another 10% for every 10 basis points the swap rates fall. Somewhere between 6.00% and 5.00% should be the bottom of the cycle, but the Overnight Index Swap market between the banks is already pricing-in rates below 5.00% early next year. My advisory firm has not provided a formal hedging recommendation on this strategy yet, but this is the type of entry tactic that will be considered. The poor liquidity in the swaps market is a real consideration and dissuades us from recommending large amounts of fixing at once. - Continue to hedge by way of purchased swaptions and swaption collars, and only convert to normal swaps when the bottom is clear to see. Unfortunately the high volatility has blown out swaption premiums and renders this strategy not that attractive. The pressure mounts on the RBNZ to cut by more than 0.50% at the 4 December MPS. Whatever the RBNZ does, I think they will then pause for a while to see whether the local and international real economies have deteriorated further in early 2009 before reducing interest rates even further to the low 5.00% area.    --------------- *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