Earthquake disaster will add to upward pressure to market interest rates

By Roger J Kerr

The interest rate markets may take a few days to assimilate what the dramatic Christchurch earthquake means for that regional economy, businesses, local government and central government.

I extend our thoughts and moral support to our numerous Christchurch clients who have to deal with the reality of the disaster.

It may be insensitive and callous to talk of financial market ramifications when Christchurch households and businesses have been so badly shocked and disrupted.

However, natural disasters do occur and thankfully New Zealand is well organised and prepared to handle the financial and economic consequences.

The New Zealand Earthquake Commission (“EQC”) has $5.6 billion invested in their Natural Disaster Fund to cover claims of property damage in an earthquake. The EQC investment fund is 30% weighted to overseas shares as an asset class, as it makes no sense (from a  risk management perspective) to have all your money invested in the currency of the economy where the natural disaster could be negative economically and force that currency value lower.

The balance of the fund is invested in NZ Government bonds, and the EQC will be starting a process to liquidate part of that bond portfolio to have the cash ready to meet claims.

So far 4,700 claims have been lodged at a maximum payout from the EQC of $100,000 per claim. Therefore, approximately $500 million is needed so far.

Insurance companies with claims on top of this will also be well prepared with cash and liquid securities available to meet the avalanche of claims. T

he EQC will be working with the NZ Debt Management Office (part of the Treasury government department) to structure a plan to sell the bonds in an orderly fashion so as to not disrupt the market and force yields higher.

Certainly, offshore and local bond traders/investors will be aware of this requirement to sell bonds into the marketplace.

Increases in long-term interest rates seem inevitable in this situation.

The $500 million estimate is likely to increase substantially over coming days/weeks.

The total cost of the repair and re-build of property and infrastructure is estimated at $2 billion, thus it seems that central Government will have to contribute funds at a time when it is increasing its own debt levels to fund fiscal deficits.

Christchurch City Council, Selwyn District Council and Waimakariri District Council will also have increased debt loads going forward as a result. 

The rally down in US Treasury Bond yields over the past few months has really lowered the funding cost of recent NZ Government Bond issues. Our long-term interest rates are highly correlated to the US bond market.

However the good times appear to be over with the less than expected decline on US Non-Farm Payrolls for August on Friday night (-54,000 compared to prior forecast of -100,000) adding to the improved US economic data in recent weeks. US 10-year Treasury Bond yields jumped up 20 basis points to 2.70%.

The NZ 10-year swap rates hit a low of 4.75% last week; however they have reversed already to 5.00% and seem destined to move higher over coming days.

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 * 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