Opinion: Get ready for rising long term interest rates

By Roger J Kerr The dramatic transformation in the shape and slope of the NZ interest rate yield curve over the last few months tells you plenty about current and future expectations for interest rate levels. We have not seen a normal, upward sloping curve for a number of years, where investors get rewarded for investing for term. The current interest rate swap yield curve from 2.90% for 1 year to 4.75% for 10 years displays two important tensions, pulling it down in the short-end and upwards in the long end. It may move to an even steeper slope (that is, lower short-term rates) over coming weeks as Alan Bollard bows to the view that the global recession will automatically send the NZ economy to negative growth and inflation in 2009 and 2010.

The much higher interest rates in the longer-end is simply reflecting the upcoming supply and demand imbalances between Government bond issuers (likely excess supply) and Government bond investors (likely insufficient demand, unless yields increase to higher levels). The net result is that our 10-year swaps, now trading at 4.75%, have most probably already seen their bottom at 4.40% a few weeks ago. It is more difficult to make the same judgement on short-term interest rates as the money markets price-in another 1.00% cut in the OCR to 2.50%. What can also be hypothesised is that sometime over the next 2/3 months the short-term rates will also find their bottom as well - that is, if you subscribe to our more positive view of an export-led economic recovery later in the year. The yield curve shape is telling us that interest rates will be substantially higher in 12 months time. Borrowers seeking to finesse their entry timing into long-term fixing of interest rates are well advised to be watching the long-term market, not the short-term stuff. Current interest rates are a "once in a decade" opportunity to lock into artificially low market interest rates. Borrowers should not go too greedy on the entry tactics, to run the risk of missing out altogether from completing the strategic imperative of fixing as high as possible for as long as possible on their projected debt portfolios. A Bank of England official made the comment last week that further cuts in interest rates in the UK was counter-productive and could actually do the economy more harm than good from the current position. Alan Bollard should take careful note of these comments as he assesses the investor and consumer responses and ramifications of his super-loose monetary policy settings. What needs to be remembered (any many have lost sight of this fact!) is that the 6% reduction in NZ interest rates from 9% to 3% over the last 9 months is a by far the largest anywhere. ------------ *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