Opinion: Local interest rates stable in an unstable world

Term swap interest rates from 2 to 10 years have settled at a normal upward sloping yield curve from 6.35% to 6.55% amidst the turmoil and turbulence of collapsing sharemarkets, currencies and commodity markets around the globe. Lower global interest rates in the short-term seem inevitable as Government and Central Bank policymakers attempt to locate the circuit-breaker to stabilise markets and restore investor confidence. Here in New Zealand the pressure will be on the Government from the banks and fund managers to get the Government guarantee scheme extended to bank wholesale borrowing before the General Election on 8 November. It seems quite imprudent to be trading this important measure off as a policy compromise between political parties negotiating a coalition after the election. Confidence in the economy and our banking system is not something to be horse-traded by politicians. The Government guarantee does distort interest rate market pricing, but lower short-term rates appear inevitable as inflation reduces and the economy remains in recession. The moneymarkets are pricing in another 0.50% OCR cut in early December to 6.00% and thereafter two more 0.25% cuts to 5.50% in January and March 2009. After that, to cut rates even further to 5.00% will require the RBNZ to have a CPI inflation forecast of below 1.00% and thus "loose" monetary policy settings. A sub-1.00% annual inflation rate would only seem possible if the economy remains in recession right through 2009 and "stubborn" price increase for electricity and local government rates reverse to price decreases. This seems unlikely and the TWI exchange rate value at 56.0 must lead to imported consumer products holding at current prices or some minor increases. European and Japanese motor vehicles look set to increase in price from the latest NZD currency depreciation. I expect the US 10-year Treasury Bond yields to remain in the 3.50% to 4.00% band, thus NZ 10-year Government Bond interest rates to remain between 5.50% and 6.00%. The swap spread between 10-year swaps and NZ 10-year bonds should decrease to 60 basis points, leaving 10-year swaps at no lower than 6.10% over coming months.  --------------- *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