By Roger J Kerr
The term “bouncing along the bottom” used to describe local interest rate direction since mid-2009 is in danger of being revised as a combination of forces are acting to drive term interest rates higher.
The five-year wholesale swap rate has lifted from 3.00% in December to 3.45% in the market today.
Not surprisingly, it is the one-side demand often seen in the swaps market that has caused the sudden change in direction.
Investors receiving fixed rate swaps have disappeared and borrowers paying the fixed rate are finally recognising the sentiment change and for the first time in three years are prepared to see value in fixing against rising interest rates.
The likelihood of any cut to the OCR by the RBNZ has been eliminated from market pricing as Governor Wheeler states the reality that the NZ economy is growing, house prices are increasing and capacity utilisation is also increasing.
It would only take a fall in the NZ dollar currency value to complete the full suite of risks that send inflation higher.
However, it is clear from the inferences from last week’s OCR review statement that the RBNZ will be closely examining the implementation of the macro-prudential measures on the bank lenders before raising official interest rates.
Nevertheless, the mood and sentiment in the interest rate market has changed to growing expectations of higher rates in 2013 and 2014.
The only factor possibly holding our rates down lower than where they would otherwise be is the monetary easing bias being adopted by the Reserve Bank of Australia as they recognise the damage the high AUD exchange rate is having on their economy.
Our interest rate market is influenced by changes in Australian interest rates; however it would be dangerous to assume that our interest rates cannot increase when Australia’s are declining.
It would also be dangerous to read too much into the contraction in the US economy in the December quarter causing lower Treasury bond yields. Behind the headlines it was massive reduction in defence spending and lower inventory build that caused the negative growth number.
Consumer spending, business investment and construction activity were all up strongly, as has been confirmed in the more recent US non-farm payrolls (jobs) data for the November, December and January period.
US 10-year bond yields have already increased from 1.6% to above 2.0% over the last six weeks, further increases are likely as US fund managers, pension funds and insurance companies off-load bonds, thus reducing portfolio durations and risk of marked-to-market revaluation performance losses.
During the emergency monetary stimulus period after 2009 the inverse correlation between US equities and bonds broke down. As the economy and markets normalise, the inverse correlation movement linkage should re-establish, thus bond yields higher (bond prices lower) as the Dow Jones Index increases.
We have seen periods when local NZ Government Bond yields do not follow the US 10-year Treasury bond yields, however they are few and far between. The correlation between the two markets is close and relentless.
Rising US yields is another reason why our swap interest rates can and will move higher.
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Roger J Kerr is a partner at PwC. 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
12 Comments
Why rise?
It sounds like NZ is under some imaginary inflationary pressures.
But the reality is:
1. Only AKL house price increases because of more immigrants and lack of land supply. External capitals are pumping up prices not a consequence of a good NZ economy
2. High Ex-rate is hurt manufaturing and will soon hurt agricultural sector given low milk price and lamb prices
3. Unemployment is easing? I think not
4. Other parts of world are recovering? not in an encouraging speed
5. Banks are already competing in the mortgage market -- 4.95% to4.99% 2year fixed term are all over the place
So, I think a rise will be further due.
Roger and more than a few have been on this bandwagon (rates will rise) for 4~5 years....if he keeps saying, well sooner or later he will be right....even if its 5+ years off. So far by staying flaoting and ignoring them Ive saved a packet.
I agree on your points they match my ones, except I dont see any real recovery......lots of wishful/hopeful thinking by the monetarists, reality I still think a drop this year or next is more likely than a rise...
The unknown though is the RB's dogma might cause a rise despite all the signs not to.
regards
Why do all economists only think inside the textbook they read at school? There is so much more going on outside rate swaps and mortgage rates.
Inflation? Outside of house prices, council rates and insurance? Certainly not in wages so little extra money to go spending.
Interest rate rise in US? I think not, not with their debt/GDP ratio!
Another crisis will be engineered shortly to ensure money stays in the bond market. Otherwise panic in bond market --> inflation --> hyperinflation, and the power that be will lose power.
Look at Japan, do you ever see borrowers volunteerily increase interest rate burden on themselves?
I dont see the bond market and inflation are so linked. If we were to get inflation that would effect bond prices not the other way around. So could you explain how you see this link please?
Really though there is no real indication of significant inflation 2 years out...
Japan is an interesting case, its borrowed for nothing by stealing off the japanese ppl as they saved for their old age by setting next to nothing rates. Trouble is those same soon to be OAPs will want to draw down their savings. When that happens the Japanese govn will have to go out into the global markets, then we'll see a rise in rates there and thats not looking too hot.
Crises they dont need to engineer anym ore than enough like Peak oil are due. nd actually I think you are wrong here as well, the Fed etc wants ppl out in the share market to prop it up and make ppl feel confident....yet many ppl are staying in Govn bonds effectively at neg rates....you have to ask why.
Retail interest rates in the US are set by who's willing to lend to the USA as Greece found out with currently 33%, no buyers = a [lot] higher price.
The problem is then that higher interest rates = cooling of economy, or given the present state a recession/depression is the result of the cooling, that would be political suicide.
regards
Roger
I agree with the commentators who say that OCR will not budge well into the future. That is not to say that it will drop; Wheeler has signalled as much.
On the other hand, it is hard to see how the RBNZ can move OCR up any time soon unless there is tightening overseas, which still looks some way off.
While our exchange rate vs the USD has been reasonably stable around 0.83-0.85, that is not the case against major trading partners such as Australia and Japan, where there has been considerable appreciation in the NZD in the last few months.
If RBNZ moves to increase OCR in the foreseeable future, exporters are slammed and the housing market takes a hit. Not good with an election year coming up.
I think RBNZ will follow a prudential "wait and see" approach on OCR and will only move in reaction to overseas direction. More likely that they will fiddle with loan ratios to discourage the over-heating housing market.
Gibber, I see numbers, I see data spread across many countires, I see Interest.co.nz's own basket of food saying pretty much the same thing, negligable inflation overall.
Finally there is also push inflation and pull inflation. Pull inflation is where you have low un-employment and wage increases, so excess money and too few goods causes price rises. Right now though we do not have low un-employment, we have little wage increases and excess manufacturing capacity. The only thing "pushing" is commodities and energy, the former is driven by specualtion and rising energy costs which is the latter.
So 1, we have the non-inflation data, 2, we have all the supporting evidence so the latter is a pretty good indication that the former is correct.
Or you could just carry on, believeing there is huge hidden inflation in a world wide conspiracy and buy (I guess) gold....
regards
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