US bond market leading a turn in sentiment and direction

By Roger J Kerr

They say that 'a week is a long time in politics' – it is an even shorter time in the wonderful world of bond and interest rate markets.

A week ago the US 10-year Treasury Bonds were trading at a market yield of 2.85% with a general flight-to-quality from global investors ahead of the Greek parliamentary vote.

Seven days later the direction and mood of the bond market has shifted on from Greece and starting to focus on the fact that QE2 has ended and the US Fed Reserve are not the big buyers of bonds anymore. As a consequence, the unwinding of pre-Greece market hedging has seen yields shoot back up to 3.18%.

Our 10-year swaps following the US and jagging back up to 5.18% from 5.00% over the same period.

The shorter-term swap rates are up 10 basis points on last week’s lows as the moneymarkets realised that the previous low pricing was becoming out of whack with reality.

Recent releases of economic data in New Zealand all points to stronger activity levels than generally expected, thus I would view inflation risks for 2012 have increased further.

Capacity utilisation numbers out tomorrow with the NZIER Quarterly Survey of Business confidence results should provide another signal to the RBNZ that inflationary pressures are gathering i.e. capacity utilisation up from the current 89.4% level. GDP growth data on Thursday is also more likely to surprise on the top-side and cause a few revisions of 2011 annual GDP growth forecasts.

By the time we get to the June quarter’s CPI inflation figures due for release in two weeks time, the short-term swap rates could be another 10-15 basis points higher again. Baring another major earthquake jolt in Christchurch, it looks like the one to three year swap rates have completed their double-dip lows (March 2009 and March 2011). The five to ten year swap rates have had three dips to the March 2009 lows over the past 12 months. However given the likely increase in US 10-year Treasury Bond yields up to 3.50% over coming months, there has to be a lot of confidence that the longer term swap rates are only heading one way from current levels - that is, upwards.

One market influence that might restrict the immediate upward direction of our two to ten year swap rates is what is going on in the Australian economy. Rightly or wrongly changes in Australian market interest rates impacts directly on our market here.

Over recent weeks it appears that some luck has finally run out for the lucky country (unless your name is Quade Cooper of the Queensland Reds – however his luck will terminate next Saturday when Richie and Kieran line him up).

Today’s economic announcement in Australia of lower job adverts, lower housing starts and lower retail sales are symptomatic of a slew of data over this past month which has all been weaker than expected. The Reserve Bank of Australia will certainly not be delivering a hawkish-toned monetary statement tomorrow. The rising NZD/AUD cross-rate from 0.7400 to 0.7750 tells us that the FX markets are already pricing-in NZ interest rates moving up to match Aussie interest rates over the next 12 months.

Borrowers contemplating fixing more debt should not be complacent about the market risks ahead of them; that is, act sooner rather than later.

Investors who have been investing short awaiting higher market rates will eventually be rewarded for their patience. The earthquakes have only delayed the inevitable by six months, but now the future is clearer for both borrowers and investors. Their respective decisions and actions over coming months will make the forecast of sharply rising interest rates a foregone conclusion and self-fulfilling prophecy. 

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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. This column was written before the Monday quake. More commentary and useful information on fixed interest investing can be found at rogeradvice.com